So you’ve finally found the nerve to leave your 9-5 and become your own boss. Great! As a small business owner in 2018, you will be in good company.  According to the U.S. Small Business Administration, there are more than 28 million small businesses in the United States ( small businesses are defined as businesses with fewer that 500 employees). But the big question is how to choose the right legal structure for your business? Each option has its pros and cons. After reading about each type, you may want to seek legal advice or a tax advisor to determine which is best for your business. Here are a list of the most popular business structures:

Sole Proprietorship

This is the easiest of all structures but puts you in perhaps the most vulnerable position financially.  As a sole proprietor, there is no separation from you or your business. You are your business. Every dollar made by the business is simply added to your personal tax return.

The advantages of a sole proprietorship is its ease in setting up.  The disadvantage of this entity is the business owner’s personal liability for the business financial obligations. You may feel an obligation regardless of the structure because it is your business. However, as a sole proprietor, you expose all of your personal assets (home, savings, etc.). This structure  also doesn’t lend itself to a sense of prestige as a corporation or LLC.

Limited Liability Company

A LLC has become quite popular and the “go-to” entity for many small business owners. It is a hybrid between a corporation and a sole proprietorship, offering easy management, pass-through taxation, and the liability protection of a large corporation. Let me explain pass-through taxation. Basically, any profits or losses incurred by the company can be passed on (pass through) to your personal tax return. Just like a corporation and unlike a sole proprietorship, it is a separate legal entity. Like a sole proprietor, there is no stock issued.

The advantages of a LLC is it provides the protection of a corporation, but taxed similarly to the sole proprietorship.  Technically, a LLC is not taxed because all gains and losses on the entity are passed on to the owners of the company and filed on their personal tax return. The disadvantages of a LLC is the expense involved in setting it up compared to a sole proprietorship.

S-Corporation

S-Corporation is technically not a business structure, but a tax filing status.  S-corp refers to Subchapter S of the IRS code. You can set up a LLC and file as a S-Corporation by submitting form 2553 to the IRS.  So, what does all of this mean and the advantages of it all. The S-Corporation is taxed like a sole proprietorship in that the company’s income will pass through to shareholders and be taxed on their respective personal tax returns. While enjoying the prestige and many of the tax advantages of a corporations, the S-corporation does not have the issue of double taxation (taxing the company and it’s owners) like a Corporation.

S-Corporations also does not have many of the tax-deductible expenses of a Corporation.  The cost of set up, the paperwork involved, and formalities are far greater in nature than a Sole proprietorship. One standout disadvantage of the S-Corporation is the restriction of “100 or fewer” shareholders, the shareholders must be U.S. citizens, and the business cannot be owned by another business.

C-Corporation

C-Corporation is completely separate from its owners existing in perpetuity surviving the owner’s death.  With a corporation, you can issue stock, raise money, and transfer ownership of the company.

A C-Corporation may have more allowable business expenses than the other entities. It protects the owners from personal liability and just may come across with a bit more prestige than the other entities.  The average person thinks, “Big” and “Deep Pockets”  when they see and hear corporation. Obviously, there is more paperwork involved in setting up a corporation and as mentioned, the income  may be taxed twice, once at the corporate level and when distributed to owners as dividend income.

 

The decision you make on the structure of your business is not irreversible.  As your business grows, you may decide that a different entity may be a better fit.  Just make sure you seek professional advice if you are uncertain which type is best for you.

 

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Terrell Dinkins is a wealth empowerment speaker and author of “One Bucket at a Time: A Woman’s Guide to Creating Wealth”.  Follow Terrell Dinkins on Facebook, Twitter, and Instagram @onebucketnation and www.onebucketnation.com

 

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