When you decide to start your own business, you are very excited to get started, but did you move too fast and choose the wrong way to set-up your company?  You always have questions like; do I want to incorporate? Do I want a sole proprietorship? If I incorporate, do I need an S-Corp, C-Corp, or LLC?

Before you can move forward with your new business, you need to answer these questions and evaluate your options before taking the next step. Below is an explanation of the different options available and the pros and cons of each option.

 

Sole Proprietorship

Sole Proprietorship is the simplest form of starting a business.  Under this entity, you the owner are held responsible for the debts of the company.  You can operate under your personal name or as a fictitious name.

Sole Proprietorship is the most popular business setup because of the simple nature and also is set up at a reasonable cost.

Because Sole Proprietorship is set up under your name, taxes are fairly easy to compare to other setups.  You are able to record your profits and loss on your normal tax filings.

Advantages:

  • You can set up a Sole Proprietorship very simple and inexpensive
  • There are very few if any, formalities.
  • As a Sole Proprietor, you are not responsible to pay unemployment tax on yourself.
  • You are able to freely mix your business assets with your personal assets

Disadvantages:

  • You are personally held responsible for debts of the business.
  • You cannot sell parts of your business in order to raise capital.
  • Sole Proprietorships normally do not retain value after the death or incapacity of the owner.

Limited Liability Corporations

businessman signing agreementLLCs have been around for over 30 years but have just recently become popular with small business owners.  The LLC allows for the liability to fall onto the company and not on you’re personally, without all of the formalities that come with the typical incorporation.

If your company has 1 to 3 owners, an LLC is probably the right choice in the first stages.  If you plan on significant growth in a short amount of time, then an LLC is possibly not the best option.

The greatest advantage of an LLC is being able to avoid double taxation.  With an LLC you are able to get the personal protection of a corporation but in a more simple form.

Advantages:

  • An LLC is allowed to have as many members as needed.
  • Members are able to receive profits and write off losses disproportionate to actual ownership.
  • Members are protected personally from suits and judgments of the LLC.
  • Members shared profit is considered as earned income.
  • Members can deduct 100% of their health insurance premiums.
  • If any of the members die or unable to contribute, the LLC will continue to run.

Disadvantages:

  • Each member’s share of profits represents taxable income, even if you did not receive any profits.
  • Members income is subject to unemployment tax
  • As a member of the LLC, you cannot pay yourself wages.
  • LLCs are not allowed for all industries in some states.

 

S Corporation

S Corporation setup is often more attractive to the small business owner than the standard C Corporation.  The S Corp has some great tax benefits but still has the same personal protection of the standard form.  With an S Corp income and losses are passed through shareholders, and that creates one level of federal income tax.

Advantages:

  • As a shareholder (Owner) all of your personal assets are protected from creditors.
  • Business losses are passed through to the shareholders, which allow you to count any company losses on your personal income taxes.
  • You can draw a salary as an employee and draw dividends as a shareholder.  This allows for some tax-free distributions for your investment into the company.
  • An S Corp can be freely transferred

Disadvantages:

  • Most states will impose ongoing fees to S Corps.  Normally not a very big expense, they are avoided in a Sole Proprietorship.
  • More chances for mistakes during tax obligations.
  • You can only have one class of stock.  There can also not be more than 100 shareholders.
  • There is close attention paid to you by the IRS.
  • Profit and loss are set by stock ownership, not like LLCs where you can allocate according to the operating agreement.

 

C Corporation

C Corp is not always the top choice when deciding to start a small business.  C Crops provide the most protection but also are the most complex to setup and to operate.

C Corps provide protection to owners, which mean that you are not personally responsible for debts and liabilities.  There are also greater tax advantages to a C Corp.

Advantages:

  • You are not held responsible for debts and liabilities.
  • You can have an unlimited number of shareholders.
  • If something happens, the company can easily be transferred.
  • You can easily raise capital by selling parts of stock.
  • There is less risk of being audited.
  • Your business expenses are mostly tax deductible.
  • You are able to avoid self-employment tax.

Disadvantages:

  • You will be subject to pay state and federal filing fees.
  • With a C Corp comes a lot more detailed paperwork, which means a greater possibility of mistakes.
  • Owners of a C Corp are subject to pay double tax on the earnings of the company.

Setting up your company doesn’t need to cost as much as it used too.  There are sites like LegalZoom can help you set-up your company and also provide resources so that you can move forward.

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