It’s most people’s dream to start their own business and have the freedom to be their own boss. Of course, that starts with coming up with a service or product to offer the public, and that’s the fun part. Making your business legal and official can be a bit more challenging, because it starts with choosing the right business entity. In its simplest terms, a business entity is created by an individual or individuals to conduct business, engage in a trade or partake in similar activities. There are various types of business entities — sole proprietorship, partnership, LLC, corporation, etc. Without fail, this is definitely on the Top 5 Most Confusing Topics for Entrepreneurs. I'm going to attempt to break this down in a few sentences per entity type:
Sole Proprietor
This is when you operate as yourself – yes, it’s true. You can be in business as yourself, without any formal business structure (like an LLC or corporation). It's the easiest structure to get started with your business since there's no entity registration; but keep in mind that when you operate as yourself, there's unlimited liability and it makes business credit harder to establish. You'll file a Schedule C with your personal 1040 tax return (due Apr 15th).
LLC (Single-Member)
This is when there's just one owner (or member) of the LLC. If you treat it like a business, you'll receive limited liability treatment. LLCs in general are the most flexible entity type in that you can elect to be treated differently for tax purposes. It does require state registration (Interesting fact: The IRS doesn’t acknowledge single-member LLCs as an entity separate from the owner. That’s why the IRS refers to single-member LLCs as disregarded entities). Unless you elect a different tax treatment, you'll file a Schedule C with your personal 1040 tax return (due Apr 15th).
It’s important to know that this entity requires state registration and can be expensive to maintain in certain states like California.In New Jersey, where we’re located, initial formation and annual report fees are pretty reasonable.
LLC (Multi-Member)
This is when there's two or more owners (or members) of the LLC. If you treat it like a business, you'll receive limited liability treatment. LLCs require state registration (general partnerships do not). Unless you elect a different tax treatment, you'll file a Form 1065 (due Mar 15th), and you'll pay the tax on your share of income on your personal tax return.
Much like a single-member LLC, this entity can be expensive in some states like California and requires you to get along with the other partners (which can be difficult if you tend to butt heads or disagree on business decisions).
C-Corps This is when the entity is separate from you (so owners aren't personally liable for liabilities and debt), and currently (as of 2022), the tax treatment is pretty favorable at the federal level. It does require state registration and significant oversight, as well as state registration. Unless you elect a different tax treatment, you'll file a Form 1120 (due Apr 15th).
On the plus side, self-employment taxes are lower with this entity and you’re able to elect S-Corp taxation. However business losses are not deductible on personal taxes.
S-Corps S-Corps aren't actually an entity; it's a tax treatment election that an LLC, Partnership or C-Corp can make. It's most popular because of the self-employment tax savings shareholders (owners)experience when they take distributions after reasonable compensation. The concept of reasonable compensation and distributions can be a bit confusing, so I rarely recommend electing S-Corp tax treatment from Day 1, and/or without professional accounting support.
Confused? That's ok -- We specialize in consulting with entrepreneurs to determine the best entity type for your business today and for the near future. Schedule a free consultation with ASE Group and let’s make your business official!
