Have you ever wondered what type of business legal structure you should choose for your business? When you decide to start a business, one of the most important decisions you have to make is choosing a legal structure for your business. The type of legal structure you choose holds the key to how you will ultimately run your business according to government requirements. Your entity type will determine the type and number of tax return(s) you are required to file, how you are required to pay yourself and your workers, the type(s) of forms, and data the government and other third-parties will request from you in the event that you have to provide financial data. It also determines how you handle your bookkeeping and the way you communicate with the IRS.
The most common types of legal structures are as follow:
For the sake of this membership site, we are going to focus on Sole proprietorships,single-member LLCs, and S-Corporations.
What is a sole proprietorship, and how are they formed? A sole proprietorship is a one-person business that has not formally been registered with the state as a corporation or LLC. This is the most simple form of business. There are no formal requirements needed to start a sole proprietorship. All you have to do is start offering a service or product in exchange for money, and you automatically become a sole proprietor. The only thing you may be required to do depending on the state and the county you live in is apply for a business license. In some states, you may need to establish a DBA (doing business as). Other than that, there is nothing else you have to do to start running your business legally.
Most booth renters are sole proprietors by default because once they start operating, they don’t do anything else to formalize their business. I can’t tell you how many times booth renters and mobile stylists tell me that they don’t own a business, FALSE. Unless you are on someone’s payroll as an employee, you are a business owner if you are providing a service in exchange for money.
Legally a sole proprietor and the sole business owner are one and the same. There is no distinction between you and your business. If your business is ever sued, your personal assets are at risk if the lawsuit is successful. One way to protect your personal assets from a lawsuit is to set your business up as an LLC or a Corporation. Keep in mind that setting yourself up as an LLC or a Corporation may still not be enough if you don’t abide by specific rules and requirements. ALWAYS consult an attorney for legal advice whenever you have questions about protecting your personal assets from legal exposure. I am a CPA, not an attorney; therefore, I am not qualified to give legal advice. I can, however, provide you with advice on how you are taxed based on your business legal structure.
I would like to begin this particular section by advising you to consult with an attorney whenever there is a question about legalities and potential lawsuits. The information I am providing in this section is general and may not apply to your specific situation.
Limited Liability Companies, LLC, for short, is the simplest way to form a business to protect your personal assets in case your business ever gets sued. LLCs are owned by one or more people depending on how many people own the business. An LLC with one owner is referred to as a single-member LLC, while an LLC with two or more owners is referred to as a multi-member LLC.
Some of the benefits of forming an LLC are:
The limited personal liability feature is one of the main reasons sole proprietors and partnerships structure their businesses as LLCs. Not only are the personal assets of the members protected, if you are a partnership organized as an LLC, the members are only liable for their own negligence and not the negligence of other members. In a general partnership that has not been set up as an LLC, all partners are personally and fully liable for the action of all other partners. But keep in mind even with limited liability protection, if someone decides to sue the business, everyone associated with the LLC is a potential target.
Limited liability companies are licensed and regulated by your state. The IRS does NOT regulate LLCs. Each state has its own LLC laws, so you must refer to the rules and regulations of your state when forming an LLC. For income tax purposes, most states follow the IRS rules, which means multi-member LLCs are taxed like partnerships, and single-member LLCs are taxed like sole proprietors. There are a few states that tax LLCs like corporations, so if you are thinking about setting up an LLC, find out how your state taxes LLCs.
To become a corporation, there are a few steps you have to take. You first have to file incorporation papers with your state and prepare articles of incorporation and bylaws. You are also required to issue state-approved stock certificates and pay a registration and/or a franchise fee depending on your state. Because each state implements its own laws, it’s essential to check with your state to see what the rules are for setting up a Corporation.
Corporations are first set up and created at the state level. Once set up, the corporation is referred to as a “C corporation.” The C corporation is the standard corporation under the IRS rules.
I know most of you are familiar with S corporations. An S corporation is not an “entity type” nor is it a legal business structure. Instead, “S corporation” status is created when a C corporation or an LLC elects to be taxed as an S corporation in order to enjoy the tax advantages associated with S corporation status.