The structure you choose for your company will significantly impact 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). You're automatically a sole proprietor if you charge your clients directly rather than working for a company that charges clients. The owner and the business are the same things in this situation.
Sole proprietorships aren’t taxed – the owner claims all profits and losses in their personal tax return.
The downside of a sole proprietorship is that it puts your personal assets at risk should you or 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 structure. You must register with the state, make a partnership agreement, and decide on a name.
The upside to partnerships is that you have multiple people who can contribute time and money to your organization and help it grow. The downside is that, as a sole proprietor, you’ll be personally responsible for the 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 like a fake person – it can buy property in its name, sue people, etc. And when a C Corporation gets sued itself, the owner's 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 taxed twice: once for the income that the business makes and then again for the income shareholders make through dividends.
With a C Corporation, you also need to comply with a number of corporate formalities to maintain your business’s status as a separate legal entity. This includes shareholder meetings and board of directors meetings (oh yeah, and you’ll have to elect a board of directors, too).
An S Corporation is similar to 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 is that S Corporations are structured so that the owners are treated as 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 business structure is key when starting a business. Your business structure has an impact on how much you pay in taxes and if you are eligible for pass through deductions.
One thing you'll want to do for sure is to talk with a CPA, such as the professionals at CMP. Do you have any questions about business entity selection? Feel free to contact us by clicking the button below.