If you want to become a small business owner, one of the first decisions you must make involves how you will choose to organize your business. If you are an individual, you have many choices: sole proprietorship, corporations (S or C), and LLCs.
Another important consideration centers on how your business formation choice will affect your taxes. This is a complex question. While there is no simple answer, understanding the options available to you is a good first step. The answer to “what is the best choice?” will differ for every business.
This form is simple, and does not require a great deal of paperwork, as you will be paying taxes on the business’s income as your personal income. However, sole proprietorships have one distinct disadvantage: liability.
If your business is sued and you are a sole proprietor, there is no legal distinction between your business and personal assets. If you are sued, the other party can go after all of your business’s assets and then move on your personal assets.
To protect their personal assets, most businesses are organized within a legal framework which ensures that the businesses’ assets are considered distinct from the owner’s personal assets. Forming a corporation or limited liability company (LLC) affords this protection.
This choice, however, is more complex than a sole proprietorship. You can choose to form a traditional “C corp” (named for the corresponding subchapter of the tax code) or an “S corp.” A C corp pays tax on its income and the shareholders pay capital gains tax on the dividend, if the corporation pays you a salary, you pay individual income tax.
An S corp, functions like a partnership for tax purposes (a pass-through entity) but has complex organization requirements (limits on shareholders, filing requirements and other rules).
To minimize the problem of “double taxation” within corporations, the entity known as the LLC was developed to allow more flexibility in taxation matters than a traditional corporation, but retain the corporate liability protection.
With an LLC, the owner or owners can choose how to be taxed. They can structure their business like a partnership with “pass-through” taxation. In this circumstance, the LLC pays no tax and the owner or owners pay tax on their share of the income.
They can also adopt a corporate tax profile, if that works better financially for their purposes. This flexibility has made LLCs the fastest growing method of organizing a business.
Before you decide how you would like to form your small business, speak with an experienced attorney in order to better ensure that your interests are protected and that your tax and liability structures are the best choices for you.