To Incorporate or Not to Incorporate:
The Pros and Cons of Different Business Entities (Part I of II)
Have you ever wondered if being a sole proprietor is your best business option? Maybe you should create an LLC (limited liability company), an LP (limited partnership), or an S-Corporation. There’s no one right or wrong answer when matching your business to just the right business entity. And the business entity you choose depends largely on your personal situation and circumstances. But we don’t want you to imply that your decision isn’t a weighty one; the type of business entity you choose will affect your liability, your creditors’ access to your assets, and your tax obligations. So it is a decision that requires pertinent information and considerable thought. Sometimes just a little knowledge can ensure that you make the best choice for you.
Sole Proprietorship
A sole proprietorship is a business owned and operated by one person. This is the most popular business type for new, small business owners, especially if they work from home. Perhaps you already decided that a sole proprietorship is the perfect match for your business right now. While there are many benefits in having a sole proprietorship, the one drawback is that you have unlimited liability for any debts or obligations incurred by the business. The business is not an entity separate from its owner, and if the business is sued, all of the business owner’s personal assets are at risk. If the business becomes insolvent, the sole proprietor must declare personal bankruptcy to avoid business debts
However, that may not be a problem you expect to encounter. If you work from your home office, you’re probably not incurring much business debt. But if you’ve grown your business enough that it requires a rental property with staff that you manage, then you might want to look at other options.
Limited Liability Company
The business entity you choose can greatly affect your personal liability. When shareholders or owners of a business are not personally liable for any business debts or obligations, they enjoy “limited liability.” The last thing you want to do is create a bsuiness where the negligence of a partner, or even an employee, puts your personal assets at risk. This week we’ll discuss the limited liability of C-Corporations and S-Corporations.
Keep in mind that every state handles each type of a company differently in set up and even taxation on the state level. What we are going over is what these business types do and generally cover for the business owner or founder. Make sure that you know exactly what and how your resident state handles each kind of corporation. This is usually found with the state’s Department of Commerce.
Corporations – Owners of a corporation are issued shares of stock and are thus called shareholders. A corporation exists independent of its shareholders, and is viewed as a separate entity, which can generate income, incur debt, and be sued. Corporations are commonly classified according to their taxation status as either C-corporations or S-coroporations. Unless the corporation elects otherwise, its income will be taxed at the corporate level at corporate rates. The following are some of the pros and cons of C-corporations:
- Pros –
- Limited liability.
- Shareholders are not required to manage the corporation.
- Continues to exist after a shareholder’s death, retirement, or bankruptcy.
- Cons –
- Filing a corporation can be expensive.
- Corporate formalities are required (shareholder and director meetings, corporate minutes book, employer identification number or EIN, etc.)
- Because the corporation’s income is taxed, and the shareholder’s income is taxed, corporation experience “double taxation.”
S-Corporation. If a corporation meets certain requirements, it can elect to be taxed as an S-corporation, with the profits and losses passing through to the shareholders to be taxed at the shareholders’ rates. Unlike a C-corporation, the S-corporation itself is not taxed, although an informational return (IRS Form 1120S) must be filed with the IRS. And S-corporations are limited to one class of stock and cannot have more than 75 shareholders. An S-corporation enjoys the same limited liability as a C-corporation and has some of the following pros and cons:
- Pros –
- Limited liability.
- Shareholders are not required to manage the corporation.
- Continues to exist after a shareholder’s death.
- Only shareholder’s income is taxed.
- Cons –
- Filing a corporation can be expensive.
- Corporation formalities are required (shareholders and directors meetings, corporate minutes book, employer identification number or EIN, etc.)
Many believe that businesses require a large number of shareholders in order to incorporate. But in most states you only need one shareholder and one director to from a corporation, and that shareholder and director can be the same person. And while that may be something you aspire to in the future, you may not feel either of these entities are the best match for your current business. That’s quite alright. Next week we will be covering more about other types of limited liability entities and how they may work for you. Keep an eye out for next week’s article about Limited Partnerships, Family Limited Partnerships, and the most common, Limited Liabilitiy Companies.
If you are considering taking the next step in the process of your bookkeeping or accounting business you have found the source that you need to have to not only gain the training crucial to accounting success, but also the training that will help you find how to grow your business. Don’t leave anything to chance by going anywhere else than Universal.
For over 25 years, Universal Accounting Center has helped people like you start their own accounting and tax practices. We recognize that 85% of the accounting opportunities are with small business so our curriculum is designed to help you learn small business accounting. Think back to our recommendation to increase your income by performing new services for new clients. When you learn small business accoutning you suddenly make yourself available to new clients whil increasing the number of services you can perform. Become a Professional Bookkeeper today.
