You may never know what results come from your action, but if you do nothing, there will be no result. – Mohandas Kanamchand Ghandi
Welcome to Day 6 of the 20-Day Business Startup Challenge! Today we’re going to choose your business entity and consult with professionals.
Choosing the right business entity is not difficult. In fact, learning about your options is quite easy, but deciding takes a bit more time.
In America, the primary entities are Sole Proprietor, LLC, Partnership, or a Corporation.
According to the US Small Business Administration (SBA), here’s a quick rundown of each:
- A sole proprietorship is the most basic type of business to establish. You alone own the company and are responsible for its assets and liabilities.
- An LLC provides the limited liability features of a corporation, but may not offer the same tax benefit (depending on your state).
- A corporation is more complex but provides liability protection and tax benefits. An S corporation is similar to a C corporation, but you are taxed only on the personal level. Both structures have additional requirements such as payroll and reporting on an ongoing basis.
- There are several different types of partnerships depending on the nature of the arrangement and partner responsibilities.
**Before we start, I am not an attorney nor am I a CPA, so this is not legal advice. This is only sharing what I learned from my attorney and CPA.
When I started Taykoff, I consulted an attorney to determine which business entity I should start. He recommended an LLC, saying it would protect my personal assets in case my company was sued. But, when I asked a few more questions about the tax requirements of an LLC, he referred me to a CPA.
Here’s what I learned from the CPA I spoke with:
- In California, there is a minimum tax requirement of $800 each year. This is required even if my business makes little profit or operates at a loss. When you combine this with the high cost of creating a corporation or LLC, it’s pretty expensive when you are not making any money yet.
- The income he recommended to determine if the cost is worth it is $70k/year. According to the CPA, if you are making at least $70k/year then starting an S Corporation is a good idea. At that point, the extra fees are worth the added tax benefits. But, if you make more than $200k/year, an S Corporation is no longer as effective. He did not recommend an LLC as it did not provide any tax benefits in California (but it may in other states).
That being said, Josh Bauerle of CPA on Fire says the determining income is $35k/year for choosing a business entity. This estimate might be for states that don’t have the minimum tax requirement or a lesser amount. Check with your CPA to get the full story and recommendation based on your state or country.
Now, wait! This isn’t the whole story.
The CPA I spoke with also mentioned exposure being a factor in choosing a business entity. If you’ve not opened any credit cards or loans in your business name and have business insurance, then your exposure should be minimal (in theory). If this is the case and you make less than the amounts above, then you should be ok with the exposure of a Sole Proprietorship.
However, if there’s risk of being sued or you have creditors, you may want an S Corporation or LLC, even if you’re making less. These options separate your personal assets (house, car, bank account) from your business assets, providing more protection.
If you do choose the S Corporation or LLC route, there will be more fees involved, including (but not limited to):
- Corporation/LLC Creation – usually handled by a lawyer (recommended), but I’ve seen some CPAs do this as well. Prices range from around $500-$1200 depending on who you use and your state.
- In California and possibly other states, you will need to pay a minimum yearly tax.
- You will also need to pay yourself a “reasonable” salary. This means payroll taxes, W2s, and all. “Reasonable” means a decent amount for your industry. For instance, if your profits are $500k per year and you are the only employee, you can’t pay yourself $20k per year. That’s not reasonable for your position. This also means it has to be consistent. You can’t pay yourself only $1000 one month because business is slow, then bump it to $10,000 when business is good. It has to stay the same month-to-month.
- You will need a payroll system. The cheapest, as of this writing looks to be the Quickbooks’ self-serve option. Self-serve meaning you send in the quarterly forms and payments yourself. If you don’t want that kind of pressure, there are more expensive options that handle that piece for you.
- Payroll taxes need to be deducted from your salary the same as when you are employed by someone else. Of course, if you are a Sole Proprietor, you have to pay a quarterly estimated self-employment tax as well.
Choosing the right business entity is important to start your new business off right. I can’t emphasize enough how important it is to consult an attorney and CPA before getting started. This doesn’t have to be costly. Most attorneys and CPAs offer a free consultation where much of this can be talked about. So no excuses! Call the professionals in your area today.
Check Yelp or get referrals and find three attorneys and three CPAs in your area. Contact each and make an appointment (if needed) for their free consultation. You want three each because some will not respond and others may not offer free consultations. Besides, the more advice you get, the better. Comment below to let us know which entity was recommended for you.