As an entrepreneur and small business owner, there are several business entities from which to select. There are several more entities. Those not detailed in this article are for larger business models. We will cover the entities we feel an entrepreneur or a small business owner should consider. The entities may also evolve over time as your business grows. The following is informational and not to be taken as professional advice. We encourage you to seek out appropriate assistance with a business and/or tax attorney.
SOLE PROPRIETOR
What is a Sole Proprietor?
Sole Proprietor is the basic form of business structure and is owned and operated by a single individual. This means your business is not an entity separate and apart from the single owner. This also means business assets and liabilities are not separate from your personal assets and liabilities.
What does DBA (doing business as) mean?
DBA is not a business entity. Rather it is an official filing with the local government or jurisdiction that informs the public that a business is operating under the assumed or trade name.
Advantages of Sole Proprietor
Sole proprietorship is a good way to test the waters on your business idea before pursuing a formal business entity. Here are some advantages
- Cost – the start up cost is nominal and most times does not cost anything to start. There are some local governments that do require a small fee to file and record their business
- Control – The owner maintains 100% of the control and ownership of the business. By definition, a sole proprietor will only have one owner who is entitled to profits, losses, and control of the business.
- Maintenance – A sole proprietor is very easy to dissolve if and when the business closes or ceases to exist. All that is needed is to cancel all licenses and registrations associated with the sole proprietor. This also includes cancelling your DBA, if you registered a DBA for your business.
- Tax Filings – Filing your sole proprietor form is to complete the IRS form Schedule C and attach it to your IRS Form 1040. If you hire employees, you’ll need to obtain an EIN (Employer Identification Number) as your individual SSN (Social Security Number) would not be sufficient for your tax filings.
Disadvantages of Sole Proprietor
Although the sole proprietor has advantages, it also has some drawbacks to consider.
- Liability Exposure – The most significant is your exposure to the liability of the business. You are personally liable for all debts or obligations of your business. Meaning if your business cannot cover its debts, creditors and lawsuit claimants can seize personal property and funds from your personal financial accounts.
- Cash Flow – You may struggle with cash flow and raising more money as being a sole proprietor as you don’t have company stock to sell. Additionally, most banks are reluctant to help sole proprietors and therefore making it difficult to obtain a loan.
- Not Easy to Change Business Entity – If you’re entertaining the idea of bringing another person that is not an employee, you’ll need to create a different business entity called a general partnership. You’ll need to obtain an EIN ( Employer Identification Number) regardless if you have employees or not. As your business is not longer a sole proprietor, a general partnership will need a different federal identification number. Your new partnership will require also require you to file a federal partnership return (IRS Form 1065) and each shareholder will receive a Schedule K-1 showing each partner’s financial portion.
LIMITED LIABILITY COMPANY (LLC)
Once you’ve tested the waters on your business concept, the next business entity to consider is creating a limited liability company. A limited liability company can be a single shareholder or can have an unlimited number of shareholders.
Advantages of an LLC
- Liability Exposure – as a shareholder, you’re protected from creditors and lawsuits going after personal property. The LLC becomes responsible for all debts or obligations where collectors and lawsuit claimants can go after assets owned by the LLC.
- Control – depending the number of shareholder, you may not be 100% in control. However, you can create a single member LLC in which you still have full control over the business and its operations.
- Some Tax Breaks – The LLC itself does not pay taxes. LLC is a pass-through tax entity and as a shareholder, you’ll pay self-employment tax on your portion of the net profits. However, your tax obligation can be further reduced, If there are more than one shareholder. You can also pay yourself a salary, which is an expense on the LLC and lowers the LLC net profit. However, the salary received is subject to tax withholding.
Disadvantages of LLC
- Cost – creating an LLC is more costly in that each state has their own fee schedule. In addition to the initial setup, there are recurring annual fees to maintain your LLC status.
- Information Reporting – LLCs are required to provide informational reports to the IRS as well as the new BOI (Beneficial Ownership Information) Report required by FIN-CEN (Financial Crimes Enforcement Network), which is the most recent entity requiring information about your LLC. The latter went into effect January 1, 2024. If you create an LLC in 2024, you have 90 days to submit your BOI report. If your LLC was created prior to January 1, 2024, you have until January 1, 2025 to file your BOI report. Regardless when you have to file your BOI, you must register with FIN-CEN.
- Additional Tax Forms – Although there are some tax breaks, the net profit of the LLC is subject to a higher self-employment tax of 15.3 % as of the time this article was written. There is also additional informational filings (IRS form 1065 and Schedule K-1) if the LLC is a partnership. Having a proficient bookkeeper / tax advisor can help ensure shareholders’ net profits are kept at minimum so as to not significantly increase a shareholder’s self-employment tax liability.
- Entity Maintenance – dissolving the LLC is not as simple as stopping your business and cancelling all business licenses and registrations. You’ll also need to file Articles of Dissolution with the Secretary of State in the state your LLC was formed. If your LLC was formed in other states, you’ll also need to file cancellation and withdrawal documents in those states. You’ll also need to file a “Final IRS Return”. You’ll also need to pay your final payroll taxes to the state’s treasurer, and finally, you’ll need to close your FEIN (Federal Employee Identification Number).
S-CORP (Subchapter S Corporation or Small Business Corporation)
Keep in mind, S-Corp is not a business entity. It is a tax classification. Once your business surpasses the tax benefits from the LLC, the next tax classification is the S-Corp. S-Corps can be as few as 1 shareholder (owner) to as many as 100 shareholders (owners). If you have more than 100 shareholders, you’ll need to change the tax classification to a C-Corp.
Some of the Advantages for S-Corp
- Tax Breaks – an S-Corp is a tax classification protecting small business owner’s assets from double taxation. The S-Corp is not subject to tax. Additionally, owners can become employees and only the salaries of the shareholders (employees) are subject to payroll taxes. Any additional net profits the LLC makes, the owners are not subject to these taxes.
- Limited Liability – owners (shareholders) are not personally liable for the business’s debt and obligations.
- Issue Common Stock – this gives voting rights to its shareholders (owners)
Some of the Disadvantages for S-Corp
- Business Management – S-Corp require a different management and shareholder structure and have unique reporting requirements. Owners can be employees and get paid a salary from the S-Corp. In most cases, the owner employment is hands-off and takes a salary as an employee of the company.
- Owner Structure – The ownership can be individuals, trusts, and estates. However, there is a limitation in that the individuals must be U.S. citizens, and the trust and estate is U.S. based (no foreign trust or estate).
- Management Structure – The management structure requires a board of directors and corporate officers to manage the company.
- Additional information – The S-Corp must file IRS form 2553 as well as the Articles of Incorporation
C-CORP (Subchapter C Corporation)
Although we feel it is unlikely for a small business owner or entrepreneur to classify their business as a C-Corp, we’ll briefly cover it in this section.
- Classification – Similarly to S-Corp, a C-Corp is a tax status and not a business entity. The business entity for both S-Corp and C-Corp could either be a corporation or an LLC. However, the most common business entity classified as C-Corp is a corporation.
- Informational Filing – only need to file articles of incorporation. There is no additional IRS form to file when forming a C-Corp.
- Cost – The filing of the Articles of Incorporation is cheaper than filing of the LLC. However, there are much higher attorney fees
- Taxation – The C-Corp is double taxed. The business is taxed and files IRS form 1120. The individual employee are is also taxed using various IRS tax forms.
- Ownership – The number of shareholders must be more than 100 and there is no maximum number of owners. Additionally, any individual, trust, or estate can be an owner of the corporation regardless of nationality.
- Stocks – a C-Corp can issue multiple classes of stock