Structuring Your Business 101
When you started your business was the first thought you had whether you’d be an LLC or an S-Corp?
It’s not uncommon for new business owners to hit the ground running. You prioritize perfecting your product or designing the ultimate client experience. And then a hundred other things end up on your to-do list.
Business structure falls to the bottom, where everything else you don’t want to touch with a ten-foot pole ends up.
Let’s take the first step towards determining your business structure. It’s easier than you might think.
Why structure at all?
As a single-owner, your business structure is important for two reasons, to 1) reduce your legal liability and to 2) reduce your tax liability.
1) Legal Liability. Protection of personal assets is the number one reason people form an LLC or incorporate. Under certain business structures, your personal assets like your home, car, or savings account, can be protected in the event someone sues you as a business owner and wins.
2) Tax Liability. Why pay more taxes than you have to? Taking advantage of certain tax loopholes in structuring your business can save you thousands in tax dollars.
The Basic: A Sole Proprietor
The simplest business structure is a sole proprietor.
Several benefits exist for sole proprietors. For one, it’s super easy to form, because it’s just you!
Administratively speaking, operating as a sole proprietor is pretty easy. If you operate your business under a name that’s different from your given name, you’ll want to register with your state. You’ll also want to keep a separate bank account for your business operations, but everything remains in your name.
You’ll want to take measures to protect your personal assets. Professional or personal liability insurance may suffice, but you’ll want to make sure you review the policy coverage closely.
Get ready to foot the bill when it comes to self-employment tax which is a whopping 15.3 percent to cover Social Security and Medicare.
Also, if you’re in a sue-happy industry or you have personal assets you’d rather not lose, you might want more protection by structuring your business as an LLC.
The Protector: LLC
Forming a Limited Liability Company (LLC) is the easiest way to ensure that your personal assets are protected if you’re sued as a business owner.
If you’re running a full-fledged business with multiple clients, there might be a point when someone isn’t happy with you and decides to take legal action. If your business is at least an LLC, your personal assets should be protected.
A bank is more likely to entertain loan applications and other business products if you operate as an LLC as opposed to a sole proprietor.
You still have to foot the bill for self-employment tax on your profits.
A little more paperwork is also going to be involved when you set up your LLC. You’ll want to talk to an accountant or an attorney to cover your bases with the paperwork and applications.
The Tax Crusader: S-Corp
S Corporations are corporations that elect to pass through corporate income, deductions, credits, and losses through to the shareholders.
No business actually starts out as an S-Corp. You elect to be taxed as such by filing with the IRS.
If you fit the criteria for forming an S-Corp, you can enjoy significant tax savings. Unlike with an LLC, your profit is essentially free from self-employment. The profit of an S-Corp passes through to the shareholder (you) and you’ll be taxed at your individual income tax rate.
Again, the trouble of more paperwork and administrative costs exists when it comes to forming an S-Corp – my best suggestion is to pay someone else to incorporate your business and establish the required tax accounts with the state and the IRS.
The other snag with S-Corporations is that the IRS requires that you pay yourself a reasonable salary, which depends on your industry and net income. If your cashflow isn’t able to support paying your salary, you might want to reconsider S-Corp status for the time being.
Where’s the tipping point to transition from an LLC to an S-Corp? That’ll depend on your annual business profit. Talk with an accountant to determine your break-even point. If your business profits between $40,000 and $60,000 for the year, you’ll want to take a closer look at being taxed as an S-Corp.
Be sure to discuss structuring your business with an accountant. They’ll be able to help with state registrations and IRS filings as well.
Samantha St. Marie, EA, attending a recent Vermont Small Business Development Center (VtSBDC) workshop on starting your own business in Vermont. What was the number one financial tip when starting a business? Hire someone to set up bookkeeping, and keep it current. We pride ourselves on helping business owners with every step. We register trade names, form LLCs, and file to become S Corps on a regular basis. Whatever you need help with, let us know!