Choosing the right business entity does not need to be complicated. In fact, learning about the business types is actually quite easy…deciding takes a bit more time.
For those of you that don’t know already, the four main business types (or entities) in the US are Sole Proprietor, LLC, Partnership, or Corporation (either S or C).
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 is designed to provide 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, which depend on the nature of the arrangement and partner responsibility for the business.
**Before we start, I am not an attorney nor am I a CPA so this is not legal advice. This is simply sharing what I learned from my attorney and CPA.
When I first started this venture I consulted an attorney, thinking they would know which business types are best. 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 tax requirements he referred me to a CPA.
After many calls and very few callbacks (seriously, I could not get anyone to call me back…are they all so busy? Then why even bother advertising if you don’t want more customers? Geesh!), I finally got through to someone that answered the phone on the 1st ring.
By the way, if you are anywhere in Orange County, CA or close to it, I recommend talking to www.thetaxperts.com – he was awesome!
Here’s what I learned from the CPA I spoke with:
In California, there is a minimum tax requirement of $800, even if my business makes little profit or operates at a loss. Combine that with the cost of creating a corporation or LLC and they can be expensive business types if you are not making much money yet.
The income he recommended for determining if it is worth it is $70k/year. According to him, if you are making more than this then starting an S Corporation is a good idea and the extra fees are worth the added tax benefits. But, if you make more than $200k/year, an S Corporation is no longer the best choice and something else (possibly a C Corporation) should be established. He did not recommend an LLC as it did not provide any tax benefits in California (it may in other states).
That being said, Josh Bauerle of CPA on Fire says the determining income is $35k for choosing business types – that might be for states that don’t have the minimum tax requirement. Check with your CPA to get the full story and recommendation based on your state or country.
So, according to this CPA, the best choices if you are making under $200k are either S Corporation or Sole Proprietor. If you are making over $70k (or $35k or whatever threshold your CPA says is correct for your state) then an S Corporation might be best, if under that threshold, then a Sole Proprietor might be best. Again, please check with your CPA for specific recommendations.
Now wait! This isn’t the whole story.
The CPA also mentioned exposure being a factor in choosing business types. If you have no creditors (you’ve not opened any credit cards or loans in your business name) and you have business insurance, then you should be ok with the exposure of a Sole Proprietorship (meaning, there should be little chance someone will try to sue you).
But, if you think there’s risk of being sued or you do have a lot of creditors, you might want to consider an S Corporation or LLC sooner in order to separate your personal assets (house, car, bank account) from that of your business.
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. I’ve seen price quotes from around $500-$1200 depending on who you choose to use and your state.
- In California and possibly other states, you will need to pay the minimum tax of $800/year (more if your company has a healthy profit – $800 is just the minimum)
- You will also be required to pay yourself a reasonable salary – with payroll taxes, W2s, etc. Reasonable meaning a decent amount for your industry. For instance, if your profits are $500k per year and you are the only employee, you can’t get away with only paying yourself $20k per year – that’s not reasonable for the position you would be in. This also means it has to be consistent, you can’t have one month paying yourself only $1000 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 to have a payroll system. The cheapest as of this writing looks to be the Quickbooks’ self-serve option, but that means you have to remember to submit the proper forms and payments directly to the State and IRS consistently. There are a lot of companies that handle this for you but they cost a bit more per month.
- Payroll taxes will 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 type is important to starting your new business off right. I can’t emphasize enough that you should consult an attorney and CPA before getting started. Both of the professionals I consulted with provided a free initial consultation – I think most do. So no excuses! Call the professionals in your area today.
Visit How to Start a Business for more details on building your business step-by-step.