Every business has a structure. No, we don’t mean brick and mortar versus online. The structure as in, its form. If you didn’t make a formal declaration regarding your business’ structure, but simply got all the licenses you needed to hang your shingle and went to work, you’re a sole proprietor. And that may have worked well for you so far. The business is you and a couple of workers, you file taxes every year like every other Joe, using a Schedule C for the business’ income, and all business decisions are yours and yours alone to make.
But – if your business is growing, you’ll want to consider a business structure that provides you with more protection. With your current sole-proprietor status, if your business gets sued, YOU get sued. If the business is found liable, YOU are liable. So not only are the business’ assets at stake, YOUR personal assets are at risk too. Sorry for the caps, but this is important: YOU NEED TO PROTECT YOURSELF.
LLC vs. Incorporation
Once you decide it’s time to leave the life of a sole proprietor and create a business with more structure, there are a couple of options: LLC, S Corp or C Corp. Each has its pros and cons that need to be considered before making the move.
A Limited Liability Company, or LLC, is the marriage of a sole proprietorship and a corporation, where each brings their best attributes to the relationship. With an LLC you don’t have to file corporate taxes, have a board of directors, pay dividends or file quarterly reports. Basically, you run the company in the same manner as the sole-proprietorship. You’re required to have members, but you can be an LLC with a membership of one (though at least two people is advised).
The other pro is pass-through taxation. This means that you file the taxes for the LLC the same way you filed with the sole-proprietorship – you don’t have to file a tax return for the business and another for yourself. One of the most important protections is limited liability, meaning if someone sues your company, only your company assets are at risk. You might lose the RAM 1500 work truck, but your personal vehicle is safe.
An S Corporation is a hybrid of an LLC and a C Corporation. S corps have stakeholders like C Corps and therefore can sell shares of the business. It also has a board of directors. However, the S Corp isn’t its own entity. It’s not required to pay taxes, instead operates like an LLC with pass-through taxation. This means that board members and other shareholders who receive any income from the business report this on their individual tax return. S Corps also enjoy limited liability, so the business’ actions can’t jeopardize the personal assets of the owners or shareholders.
This is the traditional format most people think of when they hear “corporation.” It has shareholders, a board of directors, sells stock, holds quarterly meeting and files tax returns as its own entity. A C corp offers the most protection for business owners, but this structure is also the most scrutinized form with the most rules to follow.
Also C Corps experience double taxation. The corporation is required to file taxes and then the stakeholders of the corporation have to also declare the income from the corporation on their personal tax returns. But on a positive note, if the corporation takes a loss, the stakeholders get to claim that as well.
Which Is the Best?
Choosing the right business structure depends on your long-term plans for your business. If you intend to remain the big fish in the small pond, then an LLC is perfectly fine. However, if you have plans to expand or grow your business, incorporating is a smarter move. Investors prefer to deal with businesses that already have a corporate structure, regarding selling shares and paying dividends in place. In an investor’s eyes, the business is more credible and less of a risk.
Whichever structure you choose, knowing that you are protecting your personal assets in the event of something negative occurring should help you sleep better at night.