Option 1) LLC
LLCs (Limited Liability Companies) are the most common entity for business owners and in our opinion the first structure you should consider when starting a business.
An LLC separates you (and your partners) and your company from a business and liability perspective. It also provides lots of flexibility on how your business will be taxed and run.
For an example: If somebody tries to sue you, they are not suing you personally, but suing the LLC.
What exactly does this mean? It means that they can only get as much as the assets you have in your business. But no more. Your cash, house, property and other personal assets you own will be protected.
The LLC is easy to use, easy to set up, very flexible, and very straightforward. This is the business structure we chose to operate under and are very happy with it.
What’s great about an LLC is that most states allow what is known as a ‘single member LLC’ so you generally don’t have to have a partner in order to set up a LLC. This means you’ll get significantly more protection than you would as a solopreneur Sole Proprietorship.
Like we said before, as an LLC, if anything were to go wrong your personal assets would be protected as long as they are not tied to your business.
If you have partners, you should be absolutely sure that there is a solid and clear Operating Agreement that outlines who has what responsibilities, how the business will be run, and how issues that may arise will be handled.
We understand that you might be partnering with someone you trust with your life, but having that contract could end up saving your relationship and business if something were to go wrong.
For tax purposes, your LLC will give you the protection of a corporate veil.
It is very straightforward because it is a pass-through tax entity which means you’re only getting taxed on the amount of money that you personally take out from the LLC (your personal income).
However, your LLC can also elect to be treated as a C Corporation or S Corporation from tax standpoint. (But on that note, you should speak with an accountant)
IS AN LLC RIGHT FOR YOU?
The best part of an LLC is that it gives you liability protection and the option to choose how you would like to be treated when it’s time to pay taxes.
They also require much less paperwork and maintenance than a Corporation (below). For these reasons and more, the LLC should generally be the first option considered when starting a business.
If you’d like to form an LLC, feel free to use our step-by-step LLC formation guides. But if you'd like to save time and have professionals handle all paperwork for you, look into a reliable LLC filing service.
Option 2) Sole Proprietor
As long as you don’t have any partners, are providing a product or service to customers, and have not set up any other legal entity for your business — then you are automatically a Sole Proprietor.
A Sole Proprietorship is the simplest business structure. In fact you don’t have to do anything to set it up. There is nothing to file or any reason to get an expensive lawyer. But there are a couple things you will need to do to be compliant, which we’ll get into below.
LIABILITY OF A SOLE PROPRIETOR
There is actually no difference between your business and personal liability as a Sole Proprietor. You are personally liable for debt, mistakes, or anything else along those lines that are acquired by your business.
The liability will vary depending on the kind of business you are planning on opening. And it could even be something you don’t have to worry about. For instance, if you sell digital ebooks on the history of your country, you should be in the clear from liabilities.
However, if you are starting a business that transports large rocks from location to location through populated areas or roads — you might want to rethink being a Sole Proprietorship.
SOLE PROPRIETORSHIP TAXES
As a Sole Proprietor you pay taxes on all earnings for your business. You pay a similar income tax rate on money from your so proprietorship as you pay if the money came from an employer.
You generally will not be able to raise money from investors or banks as a Sole Proprietorship. There will always be an exception, of course, but don’t expect it to be you. If you need to finance your business, you’ll probably want to keep reading.
GET A DBA (OPTIONAL)
If you are wanting to do business under a different name from your own, you will need to register a ‘Doing Business As’ or a ‘DBA’. So instead of operating as Steve Johnson you can ‘do business as’ SJ Consulting.
This way, when you receive checks or get paid for the service (or product) you offer, everything would be made out to SJ Consulting rather than just, Steve Johnson.
If you’d like to get a DBA, feel free to use our step-by-step guides. You can also zoom through the process (while having it done correctly) through a DBA filing service like LegalZoom for $99. All you have to do is answer questions about your business and they take care of the rest.
IS A SOLE PROPRIETORSHIP RIGHT FOR YOU?
As long as your business has a very small chance of liability, operating as a Sole Proprietorship might be right for you. Just make sure you keep track of your tax information and use a reliable accounting software.
Option 3) C Corporation
The biggest advantage to a C Corporation over an LLC is the ability to raise money by taking the company public.
But if you’re not planning on raising outside money like this, the LLC may be a better option because it offers the liability protection and much more flexibility from a tax perspective.
Like the LLC, a C Corporation treats the individual business owners and the business separately from a liability standpoint. So you’ll still be getting that ‘corporate veil’ that will protect your personal assets.
Note on venture capital: It’s important to keep in mind that most venture capitalists prefer investing in companies that are operating as C Corporations. This is the case because C Corporation are much more flexible from an ownership perspective.
C CORPORATION TAXES
Taxes as a C Corporation, will require more paperwork than it would as an LLC. So if you plan to take your company public eventually then you will most likely want to be operating as a C Corporation.
Here are a few additional things to keep in mind:
- Income from a C Corporation is taxed at the current corporate tax rate (Up to 35%).
- Income that is paid out to shareholders in the form of salary is then taxed again at the recipient personal income tax rate.
- Income that is paid out as dividends to shareholders is also tax at the current dividend rate of up to 20%.
- If the Corporation meets certain restrictions it can be elect to be treated as an S corporation from a tax standpoint in order to avoid double taxation.
C CORPORATION AND YOUR PARTNERS
Let’s assume later on that one of your partners want to leave the business. Since C Corporations are seen as separate entities from you and your partners, it can continue to operate with no harm or hassle done.
Just make sure that you have a well crafted Partnership Agreement that outlines terms if there were ever any disagreement between any of the partners and what would be done if somebody wants out.
Again, not having a written agreement could bring on some serious problems in the future. So make sure you do it!
HAVING A BOARD AND OWNERSHIP
They have shareholders, and they have Board of Directors. Let’s talk about the basic breakdown of how this works.
Your board of directors will likely decide who runs the company at the end of the day. So the more of an investment you take on, the more control you’re giving up.
And if the board doesn’t like you where you are in the company, they can replace you without a second thought. (As long as they have majority ownership of the overall business). Think of Steve Jobs getting kicked out of Apple back in 1985.
IS A C CORPORATION RIGHT FOR YOU?
Unless you’re planning to raise a large amount of money from venture capitalists or take your business public, an LLC will give you many of the same benefits with more flexibility.
You also have the option to start as an LLC and switch to a C Corporation when you are ready to take on an investor or board. It will be more expensive and have more legal fees in the long run, but if you prefer to start as an LLC and switch to a C Corporation, that isn’t completely uncommon. (Although it’s a lot of paperwork)
To form a C Corporation, you can use an online incorporation service like IncFile (for $49) or LegalZoom (for $79) to make sure everything is taken care of. But if you’d like to handle this yourself, use our free step-by-step guides.
Option 4) S Corporation
An S Corporation is a bit of a mix between a C Corporation and an LLC. It’s basically a pass-through tax entity.
In other words, business owners can elect to have their business treated as an S corporation from an IRS standpoint. This allows C Corporations to avoid the double taxation issues. (Because who wants to get taxed twice?)
Before the LLC was created, S Corporations were used so that business owners would not get double taxed. But nowadays most people choose to operate as an LLC because of its simplicity and flexibility.
S CORPORATIONS TAXES AND SHAREHOLDERS
The S Corporation is simply a designation with the IRS for tax purposes so that liability is the same as it is underline LLC or C Corporation that is elected to be treated as an S Corporation.
But you will need to keep in mind that your business will have to be a domestic operation, have only allowable shareholders, and may not include partnership to qualify your LLC or your C Corporation is elect to be treated as an S Corporation.
Also, your S Corporation cannot have more than 100 shareholders and it can only have one class of stock. To be treated as an S Corporation you must setup your LLC or your C Corporation on a first and then file a form 2553 with the IRS to become an S Corporation.
IS AN S CORPORATION RIGHT FOR YOU?
If you’re operating as an LLC already then there is no reason to choose to be treated as an S Corporation until the business is producing enough profit to pay yourself a substantial salary.
To form an S Corporation, you can use an online incorporation service like IncFile (for $49) or LegalZoom (for $79) to make sure everything is taken care of. But if you’d like to handle this yourself, use our free step-by-step guides.
Which Is Best For You?
This guide was built to help you decide which is the right business structure for you. At the end of the day the choice is yours but if possible, speak with a professional.
If you already know which is the best business structure and are ready to officially form a company, here are the two best resources for getting started:
- Use our free step-by-step guides for forming an LLC or Corporation.
- Have a reliable service form a business for you. A couple of the most popular are IncFile for $49 and LegalZoom for $79.
(Note: We are not practicing attorneys and this guide is not intended to be legal advice. That said, we recommend you get personalized advice from an attorney in more detail or before you legally form your business.)