What is a Business Entity?
A business entity is the legal structure of your company. Your business entity will also determine things what tax forms you file, how you pay yourself and different tax rates.
What Are Your Options?
There are four business entities to choose from:
- Sole Proprietor– This essentially means you never filed any paperwork with the state or IRS, you just hit the ground running. In this format you and your business operate as one in the same. It is by far the simplest and cheapest option for setting up, but also exposes you to the most legal liability and offers no tax benefits.
- Limited Liability Company (LLC)– In most states, an LLC may just one owner or several owners. An LLC operates just like a sole proprietor, except for one major difference: it separates the owners from the business for legal purposes. From a tax perspective, the LLC offers no tax benefits.
- S-Corporation– An S-Corporation, or S-Corp for short, is actually not an entity on its own. Instead, it is a tax election that an LLC or C Corp can choose to use. From a legal perspective, the S-Corp operates exactly the same as an LLC as it separates the owners from the business. One of the greatest benefits of the S-Corp is that it is not subject to self-employment tax on the profits in the business. This can be a major tax savings for businesses operating at a profit.
- C-Corporation– The C-Corp is a traditional corporation and has by far the worst information out there. Unlike what you’ve heard or read online, the C-Corp is a terrible option for 99 percent of small business owners.
How do you choose the right business entity for your company?
Sole Proprietor- If your business is making less than $35,000 a year in net income (income left after expenses), and you are not concerned about legal protection, you are just fine operating as a sole proprietor. Save yourself the time and money involved in incorporating and keep things simple.
LLC- If your business is making less than the $35,000 net income mentioned above, but you are concerned with legal protection, an LLC is a good choice for you. There are no tax benefits and you will have to spend some time and money getting it started, but the peace of mind the legal protection may give you is well worth it. An LLC also makes an easy transition to an S Corp when the time comes to make that move.
S Corp- If you are making over $35,000 per year net income and aren’t an S Corporation, you are throwing money away on taxes. Period. End of story. If your current tax preparer tells you it’s not worth the hassle, get a new one. At $50k net income you are saving around $5,000 a year in taxes. At $100k a year, you are saving about $10k in taxes. And as your income continues to rise your tax savings do the same. So if you are at that $35k per year net income number, you should absolutely be making an election to be taxed as an S Corp. It’s by far the biggest tax “loophole” there is.
Make an Informed Decision
The accounting and tax world is filled with terrible information. There’s a lot of people willing to give “free” information that somehow benefits them and it’s usually terrible advice. The area I see this happening the most is with business entities. There is a TON of bad information out there. So I highly advise you use these guidelines to start thinking about which is best for you and then find a legal or tax professional that you trust to discuss the decision in depth.