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Blog - Making your business official
City of Burlington
Economic Development Department
February 7, 2022
Making Your Business Official
If you are a solopreneur, a person that owns and operates a business on individually, it can be intimidating to decide how to legally form your business. This blog will highlight the differences between various corporate formations and other tax delegations to help you make a well-informed decision on which route is best for your business.
Limited Liability Company (LLC)
Many experts recommend separating your business assets to protect your personal property from liabilities arising from your business activities. Additionally, government loans and grants are greater for corporations than sole proprietors. Generally, forming an LLC helps to establish stronger brand legitimacy, which is the professional image you project with an officially formed business.
One of the first steps to form an LLC is to acquire an EIN, employer identification number, and open a separate business account. This is a crucial step since it allows you to separate your personal money from your business revenue and expenses. Additionally, the EIN creates a distinct identity for your business, much like your personal social security number that allows you to open bank accounts, apply for loans, etc.
The LLC acts as a corporate shield over your personal assets. Moreover, the formation of a corporation opens up greater opportunity to expand your business by inviting partners and/or investors to buy ownership shares.
- State filing requirements
- Annual fees
- Higher startup costs
- Tax returns can be more complicated
- Higher administrative costs (registered agents, accountants)
A sole proprietor acts as an individual who is operating a business under their name, making them one in the same. By default, many sole proprietors use their name as the legal name of their business. However, they can choose to file a DBA, doing business as, to increase the level of professionalism. The DBA is still not a separate entity, but a cover title for your business.
73% of all business in the US are sole proprietors, probably because of the simplicity associated with filing for a sole proprietorship. These individuals are not required to maintain separate business and personal banking accounts, as the government recognizes the business and sole proprietor as one. You are still responsible for applying for the necessary business licenses and permits.
- Easier tax filing
- No corporate tax like for C-corps
- No liability protection
- Limited financing options
- No taxation flexibility
- Difficult to hire employees
- Owner is responsible for company losses
Always choose a tax structure that helps minimize your tax liability. A Certified Public Accountant can help you navigate this process. There are a few preliminary screening topics that you should ask a future CPA.
- What is their subject matter expertise - must be agnostic to business model!
- How much familiarity does that person have with what you are trying to accomplish with your business?
- How can they help you grow/ scale your business?
If you and a friend decide to work together, you all report your business income on their partnership tax return, 1065. Each partner receives a K-1, which reports what portion of the profits they are entitled to. They are taxed the same as sole proprietors, but they just report their income separately.
There are three different types of business partnerships:
- A general partnership: Partners run and operate the business together and split the liability.
- A limited partnership: Some partners run and operate the business and assume responsibility for liability, while other partners do not engage in the day-to-day operations, nor do they have liability.
- A limited liability partnership: All partners are protected from liability associated with the actions of other partners.
Oftentimes, businesses develop a DBA, also known as “Doing Business As”. This registered name allows a business or sole proprietor to conduct business in another name other than their own. You can learn how to register for a DBA here. A DBA doesn’t have any legal protection like an LLC. It is simply the name your business officially uses to do business.
Corporate Entity Statuses
According to the IRS, S corporations are corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. It is a special tax status granted by the IRS that lets corporations avoid double taxation and pass their income through to their shareholders like partnerships. An S corporation is not a legal entity. To elect your business to be a S-Corp, it must be a domestic corporation with no more than 100 shareholders to become eligible for the status. You must pay yourself a reasonable salary and set up a payroll system. Experts recommend electing to file as an S-Corp once you start making over 50,000 a year, which limits your exposure to self-employment taxes.
The S Corporation is a tax election. Every state has two types of businesses, a legal business and a tax business. The legal entity is an entity that you register with your state, and a tax entity is one that you elect to file as with the IRS. You can register your business with the state for legal purposes, and still elect to be taxed as an S-Corp with the IRS for tax purposes. There is no such thing as a S-Corp for legal entities. S-Corps, sole proprietors, partnership, and LLCs are taxed as pass through entities. This means that all income that the business receives passes through to you for tax purposes, so you pay taxes individually on the income versus the business.
- Self-employment taxes do not apply to S or C corporations.
- S Corps are subject to different rules. You become an employee of your own company. Payroll services can take the taxes out. You can pay a distribution to yourself that has no self-employment taxes, which bypasses the self-employment tax. Compared to the LLC that taxes all net income.
- Most people elect S Corp status to save money on taxes, but this is not always the case. It is dependent on your situation.
A C-Corporation is a legal structure where the owners, or shareholders, are subject to double taxation. The money goes into the corporation and is taxed, then the money is distributed to shareholders who are taxed on their personal income. Thus, the term double taxation. Many large publicly traded companies are C Corporations. It is not a popular choice for small businesses.
- Limited Liability
- Owners can be US citizens or foreign persons
- Over 100 shareholders
- Separately taxed as its own entity, so it has the maximum separation between personal and business dealings.
- Unlimited State and local tax deduction from the company
- C Corp gives many options for future expansion. This structure is more complex and requires greater attention to legal documentation.
Chandler Vaughan, Project Manager, EYOS Fellow
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