Choosing your business structure:

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When it comes to choosing your entity there are many options available. The pros and cons are complicated but I’ll attempt to break it down for you here. There are Sole Proprietorships, General Partnerships, Limited Partnerships, Limited Liability Companies, Limited Liability Partnerships, C-Corporations and S-Corporations.

Sole Proprietorships: Require little to no start up or experience. Simply apply for a business license with the local authority, file a Fictitious Name Statement, and possibly a wholesale/sales tax license and you’re on your way. Your taxes are not as complicated as with a Corporation or an LLC because any income you make is your income. If you make over $400 dollars in a year you are required by the IRS to pay self-employment tax of 15.3% of all income.

Now for the bad news… When you are a sole prop you have absolutely no liability protection. You are your business, so when something goes wrong, or people get greedy, your house and your savings account are on the line. Further if you grow you may have to incorporate anyway if you plan on taking on investors.

Partnerships: Partnerships can be limited or general and are set up through a partnership agreement. I recommend staying away from both limited and general partnerships due to the fact that you are no exposing yourself to your partner’s liabilities. The pros are similar to a Sole Prop, easy to set up, simple to run. The cons are the same as well. You have no protection.

LLP,LLCs: Are somewhat new entities and take aspects of a corporation and of a sole proprietorship and combine them. For one you can elect to be taxed as either a sole prop, partnership or a corporation. You do not have to hold annual meetings or keep minutes if you elect to be taxed as a corporation as you are not a corporation, only taxed as one. You are also given liability protection from lawsuits and in some cases are better protected against a charging order with an llc, llp. (A charging order is when you are sued and the person suing you becomes aware that you own shares of a corporation and can legally take your place for any disbursements you would receive for owning the shares.) LLCs/LLPs are favored for real estate ownership. An LLC/LLP is a good business entity but may not be a perfect fit for every application.

CORPORATIONS: Can be either C or elect to be an S. There are rules on changing from a C to an S and back again.

C Corp: This is what the monster companies of the world set themselves up as, and for this reason is why I selected to incorporate. Which I will elaborate on further in this post.

All corporations provide excellent protection. The difference between a C or Regular corporation and an S corporation is that an S is passthrough. Meaning, that any income is passed through to its owner as if the owner were a sole prop, while still retaining it’s corporate protection. Many people who had elected to be an S-corp have now gone with LLCs because they are similar in nature and level of protection. However there are some subtle differences that may make a difference. I recommend checking with a lawyer or tax specialist if you have questions about the differences between an S-corp and an LLC.

C-Corporations allow you to be taxed twice. Some people might think this is drawback, but I see it as a positive. It allows me to take advantage of two different tax rates. Corporate taxes are lowest when your company earns less than 75k, it’s a paltry 15% at the time of this writing. You can (according to my sources) Generally keep 75k per year up to 225k (check with your tax advisor, I am not a tax advisor therefore this is not to be misconstrued as tax advice) as retained earnings. The IRS cares about 1 thing, which is receiving it’s fair share of taxes so if you start holding on to too much money they will want you to start disbursing it as payroll or dividends so that they can collect their share. However double taxation is not really doubly taxed because payroll is a deductible expense. You will be paying payroll taxes, half from the corporation and half from the employee. The employee cannot write off payroll tax, but the corporation can. Each dollar is only taxed once, but some dollars are taxed at the corporate rate, and some are taxed at your personal rate. IF you are disbursing retained earnings, you will have already paid 15% tax at the corporate rate the year that you earned it AND later, at the year you disbursed it out, at the personal rate. So it is best to spend any retained earnings on expansion vs payroll/bonuses.

A corporation is a separate legal entity, which you can think of as a separate person. A corporations debts are it’s own, unless you agree to be responsible for them. If your corporation is sued your personal assets are protected, meaning that you can now employ a strategy of keeping assets spread around to protect them from lawsuits. Some employ multiple entities to protect assets. As an example consider a corporation that produces soap, but rents an LLC that owns all of the buildings and equipment, controlled by You. Now imagine that a customer eats your soap and becomes violently ill and decides to sue you for medical damages. He can sue your corporation but will not get very much if the company doesn’t own anything. He would have to know about the LLC and be able to prove that the LLC caused him damages, meanwhile your home and your savings accounts are not at risk.

The flexibility of a C-corp is what drew me to it. In addition to that, I liked the fact that the biggest companies in the world are C-Corporations. Companies like Bank of America that form Political Action Committees and line the pockets of politicians with plenty of extra cash.

Lets face it, with the Obama administrations ridiculous spending habits and the rapid growth of the government, tax rates have nowhere to go but up. I feel that if you’re going to increase tax rates the broadest way to do so would be to raise taxes on the average citizen and on LLCs and LLPs. The Government has opted to allow people to treat their LLCs like C-Corps from a tax standpoint, but that does not mean that they cannot take that away, or suspend the option to be taxed as one. There are a lot of small business out there that choose to be an LLC because of the ease of managing one, however I chose the C Corp because of it’s difficulty, because of it’s long history of reliability and because if politicians start taxing c-corps too much, the c-corps will start funding politicians who want to cut taxes and cut spending.

Again, I’m not a tax advisor or a lawyer so it would be best to consult with one if you have questions about any of the entities discussed above. I will go more in depth on C-Corp requirements, how to set one up -what forms to file, how to fill them out, and so forth in further posts.