You have a business idea and a few clients lined up. You’re ready to give it a try. The trouble is you have no idea whether to incorporate. Should you start an S-Corp, C-Corp, or an LLC? What are the liabilities if you remain unincorporated? Can you start out as an independent contractor doing freelance work? Is that legal?
Where Should You Start?
I began consulting for a fee in 2008. Money started coming in. I had no idea what to do about taxes, liabilities, or a business model. Was there paperwork I needed to complete? Did I need to incorporate? Could I just report the income? Thank goodness I had a trusted accountant who knew the answer. For me, a sole proprietorship was the best fit. It’s the simplest way to do business, and it’s an unincorporated entity. All I needed to do was report any income and expenses to the IRS on a form 1040, schedule C. Easy-peasy.
When is a Sole Proprietorship Not Enough?
I can’t answer that for you. It’s a question for a professional accountant or tax attorney. What I CAN do is share five types of corporations recognized by the federal government. Let me begin by mentioning one, which is not federal, but state by state — LLC (Limited Liability Corporation). The federal government taxes an LLC as a partnership, unless the LLC requests to be taxed as a corporation.
Types of Corporations and Entities
Sole Proprietorship — This is usually a small business, solo-preneurship, or freelance work. There is no paper work involved in setting up the business, and it’s easy to disband. Proper records of income and expenses must be kept for tax reporting purposes. Depending on your state, you should file it as a DBA (“Doing Business As”) if the name is anything other than your own with your local recorder of deeds. While it’s the easiest to deal with, liability for business debt, lawsuits, and all other business matters rests solely with you.
Partnership — Is an unincorporated business with a minimum of two shareholders and a general partner who is responsible for all liability. All profits and losses go to the shareholders.
Corporation — Also referred to as a C-Corp, a corporation, unlike a sole proprietorship, stands alone offering some liability protection to stakeholders. Corporations are required to have at least one shareholder and have total control of profit distribution.
S-Corp — Have from 1 to 100 shareholders. They share similarities with partnerships but any shareholder who performs a service for the S-Corp must be paid a reasonable salary. S-corps seldom pay taxes, profits and losses are split among shareholders who report the gains or losses on their personal taxes.
Non-Profit — Charities, community partners, and the arts are among the most common non-profits, or, not-for-profits. Although they don’t pay taxes, they are responsible for reporting income, expenses, assets, and liabilities.
I didn’t write this post to offer answers, but to bring up questions. At best, it’s a limited glossary to help you talk with an adviser. You should be asking questions like:
• What are the tax liabilities?
• If we’re sued, who’s held accountable?
• How does the type of corporation fit our business strategy?
• Our company is… profitable, losing money, growing, downsizing — what’s best for us?
• Can we change our corporation status as our business changes?
This post only touches the tip of the iceberg. You need to consult a trusted professional to find what works best for you and your small business. Have you faced this decision? What sources helped you?