Choosing the appropriate way to set-up a business is essential. The choice made will impact the potential cost of doing business for the lifetime of that enterprise. That’s true in terms of taxes, operations, requirements for financial reporting, and when it comes to potential liability and lawsuit protections.
A sole proprietorship is the easiest and least costly structure to establish, and attracts the least amount of government oversight and taxation. Because of its simplicity, a sole proprietorship may be ideal for a business that isn’t exposed to liability. But there is no protective firewall between the proprietor of the business and the business itself. That exposes the owner to personal legal and financial responsibility for all debts and other liabilities. Sole Proprietors are also subject to Self-Employment tax, which has lately been calculated in the range of 15 to 16 percent of net business income.
Virtually any business selling products or services that could potential harm someone – physically or financially – needs liability protection. That includes a restaurant where someone may get sick, a rental property where someone may trip and fall, an investment company where a client may lose money, or a mechanic who fixes a car that later has an accident. Countless different kinds of businesses are subject to liability. But the LLC separates business and personal liabilities, creating a level of personal protection from business liability. The partners in an LLC business are generally shielded from the liabilities of co-partners, too. Taxes are simpler to file than with an S or C corporation, but the LLC may still be subject to Self-Employment tax.
Under an S Corp structure, the shareholders and officers are not personally exposed to business liabilities or debts. Business owners typically choose an S Corp structure when they want those protective benefits, but without the burden of the additional costs and regulatory requirements of a C Corp. There is no corporate taxation of S Corps, either, because net income is taxed by the IRS as personal income earned by the S Corp shareholders.
One of the unique traits of a C Corp is that it can endure even if the owners leave or die, making it a perpetual business structure. C Corps, like S Corps, also enjoy high levels of personal protection from liability. But corporations and their owners may both be subject to taxes on business income, and C Corps require intensive, extensive paperwork and governmental scrutiny. If a C Corp does business in more than one state in the USA, it may have to file paperwork in each state. For those reasons, C Corp status – which is expensive and complicated – is rarely advantageous to small or mid-sized businesses.
The type of structure chosen will determine the legal fees to set up the business and the cost of state taxes and tax preparation. It also determines how much time, cost, and effort is needed to comply with the law on an annual basis. Before making a final decision, it’s wise to consult a knowledgeable business attorney and a qualified CPA. They can help ensure the selection of a framework that is appropriate to the specific business and serves its needs as it grows and prospers.