The structure you choose for your company will have a huge impact on your taxes, your liability situation, and many other important aspects of running a business.
Let’s take a look at a few of the most common types of business entities:
It’s easy to start a sole proprietorship – you don’t have to file any paperwork to register as a sole proprietor or anything like that (though you may have to get a license, depending on what you do). Basically, if charge your clients directly rather than working for a company that charges clients, you’re automatically a sole proprietor. The owner and the business are the same thing in this situation.
Sole proprietorships aren’t taxed – the owner claims all profits and losses in their personal tax return.
The downside to a sole proprietorship is that it puts your personal assets at risk should you/your business get sued or take on a lot of debt.
Partnerships involve two or more people sharing ownership of a business. Unlike a sole proprietorship, you’ll have to jump through a few hoops to set up this kind of structure. You need to register with the state, make a partnership agreement, and decide on a name.
The upside to partnerships is that you have multiple people that can contribute time and money to your organization and help it grow. The downside is that, like a sole proprietorship, you’ll be personally responsible for debt your business incurs.
The “C” in C Corporation refers to the subchapter in the IRS tax code that defines this type of business entity. A C Corporation is kind of like a fake person – it can buy property in its own name, sue people, etc. And when a C Corporation gets sued itself, the owners’ personal assets are protected in most cases. The owners of C Corporations are called shareholders, as shares of stock represent their ownership.
The disadvantage to C Corporations is that they involve a lot of taxes and a lot of hassle. C Corporations are effectively taxed twice: once for the income that the business itself makes, and then again for the income shareholders make through dividends.
With a C Corporation, you also need to put up with a bunch of corporate formalities to maintain your business’s status as a separate legal entity. This includes events like shareholders meetings and board of directors meetings (oh yeah, and you’ll have to elect a board of directors, too).
An S Corporation is a lot like a C Corporation in that it’s an artificial person people create with state approval to separate their business ventures from their personal lives.
The difference, though, is that S Corporations are structured so that the owners are treated like a partnership for federal tax purposes. This means that they don’t have to pay taxes at the corporate level, which allows owners to avoid the double taxation problem that C Corporations face.
Choosing the proper form of business is key when you start up. Have any questions about business entity selection? Feel free to contact us and ask.