This is the last of a series of three blogs on legal forms of business. Today we are going to assume that you are a sole proprietorship and that your business has grown and matured and you are now concerned about protecting your family and personal assets from loss caused by your business. There are quite a few choices and any decision to migrate from sole proprietorship to a corporation, limited liability company or limited partnership should be made with your accountant and an attorney. You might think that it would be horribly expensive to consult with your accountant and an attorney regarding business types however it really is not. They perform these actions and have specific knowledge that you can get great advice for your particular business in a short period of time and inexpensively. You can of course do it on your own and if you do a great resource is the Small Business Administration (SBA). In fact, even after all these years and with my own business I still use the website for questions and links at least once a week. I encourage you to check out the SBA at www.sba.gov and “Choose Your Business Structure”
Today we are just going to focus on the two types of business structures that most of my clients end up selecting and that is the S-Corporation and the LLC.
The S-Corporation: What makes the S Corporation unique from a C Corporation (standard corporation) is that profits and losses pass through to your own personal income taxes. The business is not taxed, only the shareholders are taxed. So, if you recall the sole proprietor was taxed personally without distinction between the individual and the business the S Corp shareholder also pays the taxes from the income derived by the business. An important difference is as an S Corporation everyone who works for the business is an employee of the business so instead of only accepting draws as an owner you can be paid like an employee with withholdings and a salary. There are several reasons why you would consider an S Corporation and one of the biggest is the potential tax savings for you and your business. Members of an LLC are subject to employment tax on the entire net income of the business only the wages of the S Corp stock holder who is an employee is subject to the tax. The S Corp also allows some expenses to be written as tax credits that would not apply under other forms of business. Finally the S Corp is an independent entity which means that it can be sold and be independent from the stock holder that found it which is much more difficult to do as a sole proprietor. It also means that as an independent entity the business is separate from you the stock holder in the event of a loss or lawsuit.
The LLC: This has proven to be a very attractive form of business in the past ten years. The LLC is not a separate tax entity so just like a sole proprietor all federal income tax is passed on to the LLC members and paid in their personal income taxes. If you are a single member LLC than you would pay income taxes on a 1040 Schedule C just like you did as a sole proprietor. If there is more than one owner/member you would file taxes as a partnership. An LLC could even be designated as an S Corp and file taxes as we discussed earlier. The LLC / S Corp is a pretty complex legal form of business and it would be unusual for you to necessarily need this designation but would be worth mentioning to your accountant and attorney.
The LLC gives you many of the benefits of a sole proprietor but limits your business liability like a corporation. This is one of the most attractive aspects of this legal form of business! It is also much simpler in record keeping and registration and generally costs less to start up than an S Corp. Also, unlike an S Corp there are fewer restrictions on how the member/owners distribute profits. Members of an LLC are considered self employed so just like a sole proprietor they must pay the self employment tax to social Security and Medicare. The entire net income of the LLC is subject to this tax which is a consideration for the S Corp which as an independent legal entity pays half the Medicare and Social Security charges.
In Conclusion: There isn’t necessarily any perfect one size fits all legal form of business however it is important to note that as your business grows and changes your needs change to. Don’t be afraid to get professional advice. The minimal cost of advice could be paid for in your first year in tax savings not to mention the liability protection for your family and assets.