Make no mistake, it’s a fantastic time to start a new business. With more of us spending more time at home than ever, turning that side hustle into your primary source of income can be the realization of your wildest dreams.
While passion for products or services drives many small business owners to commit to building a business, very few are excited about paperwork and taxes. However, something doesn’t have to be exciting to be important.
One of the most crucial decisions you need to make is what kind of business do you want to be? An LLC, C-Corp, S-Corp, or Sole Proprietorship. Deciding which type of business you are will have significant implications for your success.
You may have seen all the TikToks, digested all the Instagram Reels, and read all the articles from gurus going on and on about the benefits of the four main types of business ownership (Sole Proprietorship, General Partnership, Limited Liability Company (LLC) and Corporations C-Corp and S-Corp). However, we lose the nuance in 30- or 60-second clips and can’t always vet the source. In this article, we’re going to explore the four main paths that you can choose to reach your goals. As well as why you should always lean into the experts to give you that advice.
Let’s dive in.
First Step to Beginning your New Business
If you’re ready to take the next step and turn your idea into a reality, you aren’t alone. According to the U.S. Census Bureau, 5.4 million new business applications were filed in 2021 alone. This marks an increase of over 1 million from the previous year. Wild, right?
While you may be excited to plunge headfirst into the world of small business ownership, there are a few items to address first:
- Are you going to have partners?
Knowing whether your new business will be a solo venture or if you’ll be working with partners is crucial. It will inform a host of decisions, including which type of business you file.
- What are your goals?
Different businesses have different goals. Some want to become market leaders, while others are satisfied with modest growth. Where do you see your business in five years? Take the time to create a business plan. Knowing where you want to go will help you set the groundwork early.
- Understand your tax burden and risks
It’s never too early to start protecting yourself from liabilities for your business. Taxes, losses, and bankruptcies are all genuine risks for business owners. Safeguarding yourself from the financial burden is a must — and is linked to the type of business you start.
The Four Types of Businesses
So you’ve got a plan, have a fantastic product or service, and you’ve chosen a name. Now what? Now it’s time to select the perfect type of business to file.
The Four Business Models:
- Sole Proprietorship
Each has its own set of pros and cons, requirements and restrictions for its owners. Let’s explore each and find out which is suitable for you.
In terms of business types, a sole proprietorship is the simplest to establish. Depending on the city and state you do business, you can usually set up a “doing business as (DBA)” and obtain a license. At the end of the year you simply include your profits on your personal tax return, there is no need to file a business return. It isn’t taxed separately but is included with the owner’s personal income.
Depending on your state, you may need to obtain a business license to give you the right to conduct business. However, the work involved is slight in comparison to other options.
It’s simple to start, structurally uncomplicated, offers tax deductions for business losses and expenses on your personal tax return, and gives you an easy exit if you want to stop.
The great thing about sole proprietorships is how easy it is to start. Want to create a sole proprietorship? Great, you just did.
Since a sole proprietorship isn’t taxed as a business, it offers no liability protection to the owner. If someone sues your company for something they’re not happy with, you are at risk of having a levy on your wages and a lien on your property. You can also be personally liable for any debt incurred by the company. It works the other way too. Your business assets are at risk for your personal actions.
Who is a Sole Proprietorship for?
Simply put, a sole proprietorship is for anyone looking to start a simple business fast and with minimal effort, including contractors who can capture taxes on their individual return.
A limited liability company (LLC) has become one of the most popular business types since its inception. The LLC has some significant advantages from both a structural and tax perspective.
You must file paperwork with the state and pay a filing fee. There is also a fee charged to form an LLC. In addition, LLC’s, like any public company must also file an annual report, generally with the state, detailing the companies activities for the year.
LLCs differ from Sole Proprietorships in that they allow for more than one owner, and limit risk and liability between the owners and the business. For example, your personal assets are safe from personal lawsuits and creditors that your partners might experience. They also provide legal protection to the owner or members of the business, which helps in the case of lawsuits or bankruptcy.
An LLC offers some exciting benefits, such as having owners (and the business itself) receive legal protection from debts and lawsuits.
Similar to a sole proprietorship, an LLC offers you “flow through” taxation, so you can report your profits, losses and expenses on Schedule C or your personal income tax return.
There are initial costs associated with establishing and operating an LLC, as well as other documents that you will want in place as you run your business.
In addition to renewing a business license, there are other things an LLC has to do each year, or every other year, depending on where the business is located or doing business. Failure to perform these duties can result in losing the limited liability that the LLC offered.
Who is an LLC for?
An LLC is for small business owners who want to distribute profits among multiple people anticipate future growth or are looking to protect themselves from potential lawsuits.
An S-corporation is different from an LLC or Sole Proprietorship in a couple ways. Unlike a regular C Corporation, an S-Corp helps owners avoid double taxation on income and business revenue.
An S-Corp usually begins as a Sole Proprietorship, an LLC or a C Corp. They are called S-Corps because of the filing for S Election form that a company files with the IRS. However, you need to be aware that this business structure has some potential downsides, especially for small businesses.
Tax benefits, liability protection, attractive to investors.
Costly to maintain (in order to reap the benefits of S Corp, the company must maintain records of compliance filings), stringent rules for qualifications (limitations of who cannot have S-Corp, ex, non-U.S. citizens, limitations of the number of shareholders, etc.), complex management, closer IRS scrutiny, types of stock are limited.
Who an S-Corp is for
Businesses with established revenue streams seeking tax benefits— S-Corps, LLCs and Partnerships all have flow through taxation, so no double tax like C-Corp.
The last business type is one of the most complex and often misunderstood: The C-Corp. While offering some of the same benefits as S-Corps, C-Corps are taxed as separate entities.
Unlike S-Corps, C-Corps aren’t limited to one type of stock. Unlimited shareholders can stake investment in the company, making it attractive for corporations like Apple, Amazon, and Bank of America.
A C-Corp also opens its owners up to double taxation. While C-Corp structure can have benefits when seeking investment, it adds another layer of complexity when managing your business.
Attractive to investors and other corporations.
Less flexible than an LLC or S-Corp, double taxation.
Who is a C-Corp is for?
A C-Corp is for businesses looking to attract investment, specifically corporations.
Which is Right for You?
Before you decide which business structure is suitable for your company, it’s essential to understand the benefits and drawbacks of each option. The good news is that there isn’t a single best solution for all companies. The final decision can be as simple as choosing what feels suitable for your future.
However, to set yourself up for the most success, it’s always best to talk with a professional. Finding a trusted partner to walk you through your options will help you find a path toward your goals.
In fact, here at Semaphore we have experienced professionals whose only business is the creation of business solutions to fit your needs. Building a well-managed business, whether a sole Proprietorship, LLC, S-Corp or C-Corp, requires operational excellence to thrive. We thrive on making sure you have the knowledge you need to build and protect the business you want. From gaining exposure on social media and partnerships with larger brands to bookkeeping and payroll, taxes and insurance, we have you covered.
For more information, reach out to Shawn O’Buckley, Chief Compliance Officer at Semaphore Corporate Solutions at firstname.lastname@example.org or (720)762-8728.