Not sure if you should set up an LLC or Sole Proprietorship for your business? Maybe your business qualifies as an S-Corp? No worries girl boss, you’re not alone. I’ve had the same questions when I started my blog business.
Fortunately, I received great guidance from my CPA Amy Northard. Over a few email exchanges and doing my own research, I’ve created a short guide to provide the basics of an LLC, Sole Proprietorship, and S-Corp.
Partnership Limited Liability Company (LLC):
Must have two or more owners
Protection of personal assets if business is sued
Separate tax return is filed for the partnership (form 1065)
Depending on your state, there can be high renewal fees or publication requirements.
Many states have a franchise or capital values tax on LLC’s
The LLC for a partnership is created the same way as a Single-Member Limited Liability Company (SMLLC) – by registering with your state. It has all the same limited liability protection as the SMLLC, but it’s for two or more owners.
You would report your annual income and expenses on a Form 1065 partnership return, which is completely separate from your personal tax return.
No tax is paid with the return; the income and expenses flow through to your personal tax return through a K-1 form, where it’s taxed.
For instance, say my CPA Amy has finished preparing the partnership return. No tax is due with the return because the partnership itself isn’t taxed. Instead, Amy would give me a K-1 form.
Basically the K-1 form reports my individual share of the business’s income and expenses. When it’s time to complete your personal tax return, Amy would enter the information from the K-1 form into the tax program.
Now, when I look at the front page of my federal tax return, I’ll see your share of the income or loss generated by the partnership on line 17. This is a little different than a SMLLC…
Single-Member Limited Liability Company (SMLLC):
For businesses with one owner
Must keep business and personal funds separate
Protection of personal assets if business is sued
Income taxes filed with a Schedule C attached to your personal tax return
Solopreneurs, the single-member LLC is a great option for a single owner. Especially, if you prefer more liability protection than a sole proprietorship and not yet ready to take the leap to become an S-Corporation. If you properly keep your business and personal purchases separate, the LLC will limit your liability in the event that something happens and you are sued.
It doesn’t make you invincible though. If the court decides that you haven’t kept things separate enough, it could break down that protection, and your personal assets could still be taken. To create a SMLLC, you will register with your state. Each state has their own form, but it’s usually called “Articles of Organization” or something similar.
In some states, the annual fees can be minimal (less than $200). But in others, fees can be closer to the $1,000 range. You would report your annual income and expenses exactly like a sole proprietor, by using the Schedule C.
Easiest business structure to form
Income taxes are filed with a Schedule C attached to your personal tax return
Owner is personally liable for any financial obligations of the business
The tax reporting is pretty straightforward with this structure. You report your annual income and expenses on a Schedule C that’s filed with your personal tax return. If your state has an income tax, then the info you reported on your federal return will just flow right onto your state return.
A Sole Proprietorship is the easiest business structure to form because it’s just you, and it begins when you make your first sale. On the federal level, you don’t need to do anything to create a sole proprietorship, but your state or city may require permits or licenses enabling you to operate.
Many people do not think that they are considered a business unless they form a LLC. However, according to the US government, a sole proprietorship is just as much a business as anything else. The downside to the sole proprietorship structure is that the owner is personally liable for any financial obligations the business may have. So if your business gets sued, the plaintiff can come after your personal assets like your home, car, and any future income you make in order to satisfy the court’s ruling.
An S-Corporation is a small business corporation. The S-Corp election allows the owner(s)/shareholder(s) to only be taxed at the individual level instead of at both the corporate and individual level. We’ll go over an example of this below.
The big advantage of the S-Corp status is a tax concept called pass-through taxation. Pass-through taxation means that your company isn’t taxed on the income it generates. Instead, this income can be distributed to the owner(s)/shareholder(s).
Another important advantage is the limited liability protection for owners and shareholders. There is an extra layer of security for your personal assets in the event your company is dissolved or is being sued.
Your company can attract investors through the sale of shares of stock, giving you investment opportunities for the continued growth of your business.
Your business will continue to exist even if the owner leaves, retires, or dies.
There is additional paperwork involved. It is necessary to incorporate the business by filing Articles of Incorporation with your state, obtain a registered agent for your company, and pay the appropriate fees.
Many states impose ongoing fees, such as annual report or franchise tax fees. These fees are typically minimal and in most cases you will recoup the amount you paid in fees with tax savings.
Because the S-Corp status allows for distributions to a shareholder, the IRS scrutinizes payments to make sure the characterization conforms to reality.
If the company tax status is compromised by either non-resident stockholder or stock being placed in corporate entity name, the IRS will revoke the status, charge back-taxes for 3 years, and impose a further 5-year waiting period to regain the tax status.
Need more clarity on the different types of business structures?
It’s a big decision so make sure you do gather as much information needed to do what’s best for you. Feel free to schedule a chat with my CPA Amy Northard here!
Be your own Creative Financial Officer (CFO).
As a girl boss, it’s important to know your numbers like a boss. If you’re looking for a little kickstart to get your finances in order, join Amy and other girl bosses over at the Be Your Own CFO program. The Be Your Own CFO program includes access to a Certified Public Accountant and a membership site. The site includes short videos and guides that will walk you through the main topics in each lesson.
You have time to review and ask questions throughout the program. Amy has a private Facebook group for check-ins, questions, and accountability!