Creative Entrepreneurs and Business Structures
Some common questions I get all the time from Entrepreneurs are, “What’s the difference between a sole proprietor, LLC, and a Corporation?” Quickly followed by “How do I know which one is right for me?” Choosing the right structure can have big implications for your liability and for your taxes. There’s not a one-size-fits-all answer, because each business is different and you need to find the right fit for yours. Here’s a quick rundown of the difference between the three structures most likely to fit your business.
If you’re asking the questions I just mentioned and you don’t know the answers, you’re a sole proprietor. That’s because any single owner business that hasn’t chosen a different structure and gone through a process to set it up is considered a sole proprietor by default. Whether or not you should remain one, depends on your business.
A sole proprietorship is the simplest because it takes no set-up. It also doesn’t require you to follow any certain routine, like the meetings required for corporations. All your income is filed on your personal taxes as self-employment income, with your business being “disregarded” by the IRS.
You may still need to license your business with your city or file for a fictitious name if you name your business something besides your legal name, but for tax purposes it’s very straightforward.
Sound great, right? The problem is that a sole proprietor has no liability protection if someone should come after you. This might not seem likely in your business and those for whom it is least likely will probably be the best fit for sole proprietorship. However, think carefully about the chance that a client could sue you for some kind of loss, a collector could come after you for inability to pay a debt, etc. For a sole prop, your personal assets are fair game to anyone coming after your business.
Limited Liability Company
Now that we’re thinking about liability protection, an LLC might sound pretty good. It stands for limited liability company and creates a separate business entity that you own. It can have one or multiple owners. The biggest benefit is that your business is no longer the same as you, so your personal fortune is no longer on the line if your company has a liability issue.
Another big perk with an LLC is that you have some taxation options. You can choose to be taxed as a corporation if that turns out to be cheaper for your particular business. Sole proprietors don’t have this choice.
An LLC does take a little work to set up but nothing too scary. You’ll have to file with your state and pay a fee, along with some ongoing requirements to stay current. If the tax benefits and liability protection are needed, these requirements are well worth it!
If you decide to go the Corporation route, an S Corp is the most likely choice for a solopreneur or very small business. An S Corp is a corporation that has made an “S election” to be taxed as a passthrough. That means that your company doesn’t pay corporate taxes, you just pay tax on the income on your personal return more like an LLC or sole prop.
The requirements for maintaining an S Corp are more than an LLC so you have to weigh the benefits. One major reason for small businesses to use this structure is saving on social security and medicare taxes. This is because you can earn income as an owner rather than an employee of your own company and that affects what taxes need to be withheld. You have to be really careful with this strategy because the IRS is cracking down on potential tax evasion in this area. You have to pay yourself a reasonable salary for the work you do in your own company or they can reclassify it for you. This may come with a penalty.
Still have questions on which is the best structure for you? Feel free to reach out and ask!