Congratulations, you’ve decided to start a business!
Simply taking the first step is the hardest part. But now you’re probably overwhelmed with questions about how you need to set up your business.
The number one question I get asked by business owners is if they need to set up an LLC or corporation for their company.
The answer is: it depends.
You can absolutely run your business without doing any corporate formation, which is the easiest and simplest way to get started. If you’re solo, it’s called a “sole proprietorship,” and if you have partners it’s called a “common law partnership”.
There are two things to think about when deciding whether to form an LLC or corporation: liability and taxes.
An LLC (Limited Liability Company) or corporation can protect your personal assets from being taken if someone sues you for something you do in your business.
If you don’t form an LLC or corporation for your company, you’re treated as one and the same as your business. So, if you get sued, a court could take your personal assets (house, car, bank accounts) to pay damages for things that went wrong in your business. No one wants to lose their savings because of a business deal going south!
If you have an LLC or corporation, then the court would only be able to take any business assets or bank accounts to pay the damages.
In my opinion, the liability protection is the most important reason to form a corporate entity.
Some businesses have higher risks of being sued than others – a graphic designer, for example, is very unlikely to damage a client while doing her work (although she could be on the hook for copyright infringement if she doesn’t use properly licensed images and fonts). A company that takes people skydiving will have a much higher risk of getting sued if something goes wrong while working with a client.
Forming and keeping up an LLC or corporation can cost anywhere from a few hundred to several thousand dollars a year, depending on the state where the business is located. It’s important to weigh how much protection you need against the cost.
Second issue, taxes.
An LLC or corporation may (but may not) save you money on your income taxes.
This will be different in every state so it’s well worth finding a local accountant who works with small businesses. She can run the numbers walk you through the tax pros and cons for the different corporate forms.
If I decide to form an entity, what’s the difference between an LLC and “S Corporation”?
An LLC and “S Corp.” (a type of corporation commonly used by small businesses) will both provide liability protection for your personal assets.
The biggest differences are:
- How much paperwork you have to file each year to maintain them.
- How they are taxed.
- Management and ownership structure.
Every state has different rules about LLCs and corporations, but in general, corporations require more formalities and paperwork to be filed with the state every year.
Corporations usually must hold an annual meeting and file minutes from the meeting saying what happened with the state, and may have to follow other state or federal regulations. LLCs, on the other hand, generally only have to file an annual report, which in many states can be filled in quickly and easily on the state’s Secretary of State website.
These differences are important, because if you don’t follow all of your state’s rules to a T, you can lose your liability protection!
It’s important to think about whether you will actually follow all of these rules every year, and how expensive it is to do so.
On the tax issue, an LLC is basically taxed the same as a sole proprietorship — the company doesn’t pay taxes, the individual LLC members pay taxes on the company’s revenues after deduction of expenses, called “pass through” taxation. An S Corp. avoids the double taxation of other corporate structures because the company is not taxed on its profits, its owners are only taxed on salary and distributions.
Again, you should discuss which form makes sense for your business with a local accountant who works with small businesses.
The third issue will not be much of an impact for most small business owners, but corporations generally offer more flexibility in ownership and management structure. For example, in some states an LLC cannot be owned by a person outside the U.S. Only a corporation can issue stock certificates; it sometimes can be more difficult to sell your ownership of an LLC than if you owned part of a corporation and can simply sell your stock.
Disclaimer: This article is intended to give general business information, not legal advice.
ABOUT THE AUTHOR:
Autumn Witt Boyd is a copyright, trademark, and business lawyer with more than 10 years of experience. She loves to work with creative entrepreneurs with growing businesses that make online content, videos, music, books, courses, images, music, software, or new technology. You can learn more about her at awbfirm.com.