Have you ever thought about working for yourself? Everyone dreams of working for themselves at some point in their career. The money, the glory, the control and more are all possible. However, so are extremely long nights, payroll, tax burdens and responsibility for everything from sales to production to choosing your phone service. To make sure that you keep your tax burden to a minimum, that you protect your personal investments from being affected by the actions against your business or employees, and that you present your new venture in a professional way, you have a number of choices as to how to legally form your company. Welcome to our five-ring circus. On the far left we have the sole proprietor ring. In the second ring we have our tightrope walkers* forming a partnership. In the middle ring you will see the leaping lipizzaners in the Limited Liability Corp., or Llc. In the fourth ring we have the popular S corporation, and, finally, in the big ring with the parading elephants is the C corporation.
Each legal status has its benefits and negatives. It’s the working for yourself! Pay sharp attention to the rings, as you don’t want to clown around with your decision.
In the sole proprietor ring, you will see a crowd. This is the most popular type of business status, because it’s also the easiest. All you have to do is say you are in business, and like magic, you are in business. You are the business. Your name is the business name. No extra taxes. No extra forms. Just you and your abilities. All the income and expense for your business go onto your personal tax form.
You can go by a business name other than your given name as long as you file for a fictitious name, or DBA, that means «Doing Business As». DBAs are great to allow you to sound more like an ongoing business, but you can’t use the terms corporation, corp., or inc. in the name, as those terms may only be used by legal corporations. The negatives are that you have no legal protection separating your personal items and investments from those of your business and you don’t get some tax benefits. Your business ID number is your social security number.
Watch out in the second ring, as running a partnership is like walking a tight rope. A partnership is simply a relationship between two or more persons who join to carry on a trade or business. Each contributes money, property, labor or skill and share in the profits and losses of the business. The business itself does not pay taxes. Instead the profits or losses are ‘passed through’ to the partners to include on their personal tax returns. Their personal property also has no protection from judgments against the partnership.
The danger in the partnership ring comes from balancing personal relationships with money, time, effort and expectations. The best safety net is a detailed contract outlining the responsibilities of each partner.
The middle ring has become quite popular over the last five years, as more people take advantage of the low-cost, tax-benefit and protective nature of the Llc., or limited liability corporation. Not all states offer this legal status, so it’s not always an easy choice.
The fourth ring serves the purpose of most small businesses, the S corporation, also known as the Sub-S or Sub-chapter S corporation. This corporate status offers much the same legal protection as a full C corporation, but all the profits or losses pass through to the shareholders to pay tax on. The company itself is exempt from federal income tax other than tax on certain capital gains and passive income. All earnings must be distributed to the shareholders each year. An S corporation may also have only up to 100 shareholders and offer only one class of stock.
The large elephant C corporation ring at the end is for larger companies. A C corporation may leave most of the corporate earnings in the corporation for future growth and may deduct the cost of fringe benefits to employees. Corporations provide security to the stockholders from the corporation’s liabilities and may have a fiscal year, which is different from a calendar year. The profit of a C corporation is taxed when earned and then the shareholders are taxed again when profit is distributed as dividends. The shareholders, however, cannot deduct corporate losses. A C corporation may have more than one class of stock, any number of shareholders and those shareholders may be nonresident aliens, other C corporation, partnerships or some trusts.
While working for yourself, you are not stuck in one ring. You can jump into another ring and change your legal business status. You can form a partnership or corporation as any time of the year. However, if you want to change your status from an S corporation to a C corporation, or vise-versa, you need to do it before the 15th day of the third month of the tax year, or the new status won’t be applicable until the following tax year.
Before you decide to run away and join the corporate circus, find a good accountant to help guide you into the ring that is right for you. Ask a trusted and successful company in your field for a recommendation to a great accountant. An accountant who gives you bad information is like getting an expensive pie in the face.