Did you Know?
You could be Personally, Legally, and Financially Vulnerable if your business is NOT structured properly,
If you own a small business, protect your assets by incorporating
Sole Proprietorships, or Partnerships do not protect your personal assets
A properly structured business has significant tax advantages as well.
Business Startup Possibilities
Sole Proprietors or Partnerships
A sole proprietorship is a one-person business that is not registered with the state as a limited liability company (LLC) or Corporation. There is no need to file any paperwork with any state or federal agencies to set up a sole proprietorship. A sole proprietorship is created by going into business for yourself. In the state of Washington, a Master Business License from the State Department of Licensing (DOL) is required.
Legally, a sole proprietorship is inseparable from its owner — the business and the owner are one and the same. This means the owner of the business reports business income and losses on their personal income tax return, and is personally liable for all business-related obligations, such as debts or court judgments.
Similarly, a partnership is simply a business owned by two or more people who haven’t filed papers to become a corporation or a limited liability company (LLC). No paperwork needs to be filed to form a partnership — the arrangement begins as soon as a business is started with two or more people. Again, a Master Business License from the State Department of Licensing (DOL) is required.
As in a sole proprietorship, the partnership’s owners pay taxes on their share of the business income on their personal tax returns. They are each personally liable for the entire amount of any and all business debts and claims.
Corporations and LLC’s
In the state of Washington, anyone who operates a business, alone or with others, may incorporate or form an LLC. Some of the benefits of either Incorporating, or forming an LLC are listed below.
Reduces Personal Liability
Incorporating helps separate your personal identity from that of the business. Sole proprietors and partners are subject to unlimited personal liability for business debt or law suits against their company.
Creditors of the sole proprietorship or partnership can bring suit against the owners of the business and can move to seize the owners’ homes, cars, savings or other personal assets. Once incorporated, the shareholders of a corporation have only the assets of the corporation at risk, and usually no more.
Adds Credibility
A corporate structure communicates permanence, credibility and stature. Even if the owner is the only stockholder or employee, an incorporated business may be perceived as a much larger and more credible company. Seeing “,inc.” or “corp.” or “LLC” at the end of a business name can send a powerful message to customers, suppliers, and other business associates about the commitment to the ongoing success of a venture.
Tax Advantages
Deductible Employee Benefits, as well as deductible salary expenses (even for owners) Equally important, incorporated businesses can reduce tax liability in ways not available to Sole Proprietors, and Partnerships. In other words; The Business Owner can keep more of the profits.
Note: You should consult with your accountant for specific details related to tax issues
Incorporating usually provides tax-deductible benefits for the owner(s) and employees. Even if the owner is the only shareholder and employee of the business. Benefits such as health insurance, life insurance, travel and entertainment expenses may now be deductible. Best of all, corporations usually provide an increased tax shelter for qualified pensions plans or retirement plans (e.g. 401K’s).
Easier Access to Capital Funding
Capital can be more easily raised with a corporation through the sale of stock. With sole proprietorships and partnerships, investors are much harder to attract because of the personal liability. Investors are more likely to purchase shares in a corporation where there usually is a separation between personal and business assets. Also, some banks prefer to lend money to corporations.
An Enduring Structure
A corporation is the most enduring legal business structure. Corporations may continue on regardless of what happens to its individual directors, officers, managers or shareholders. If a sole proprietor or partner dies, the business may automatically end, or it may become involved in various legal entanglements. Corporations can have unlimited life, extending beyond the illness or death of the owners.
Easier Transfer of Ownership
Ownership of a corporation may be transferred, without substantially disrupting operations or the need for complex legal documentation, through the sale of stock.
Anonymity
Corporations can offer anonymity to its owners. For example, if you want to open an independent small business of any kind and do not want your involvement to be public knowledge, your best choice may be to incorporate. If you open as a sole proprietorship, it is hard to hide the fact that you are the owner. And as a partnership, you will most likely be required to register your name and the names of your partners with the state and/or county officials in which you are doing business.
Subchapter S Corporation
A Subchapter S Corporation is a general corporation (commonly referred to as a “C” corp) that has elected a special tax status with the IRS. Subchapter S corporations are most appropriate for small business owners and entrepreneurs who can benefit from the business advantages of being incorporated, but do not wish to indure the “double taxation” attributed to a “C” Corporation.
When a general corporation (“C” corp) makes a profit, it pays a federal corporate income tax on the profits. When the profits are then distrubited to the owners (stockholders), the stockholders must report the income as personal income and pay income tax on that distrubution. S Corporations avoid this “double taxation” (once at the corporate level and again at the personal level) because all income or loss is reported only once on the personal tax returns of the stockholders.
For many small businesses, the S Corporation offers the best of both worlds, combining the tax advantages of a corporation, without double taxation, as well as the limited liability benefits. And, depending upon the specific situation, there can be additional tax benefits related to the owner’s salary. Click here for an example.
Limited Liability Company (LLC)
The LLC is not a corporation, but it offers most of the same advantages. Many small business owners and entrepreneurs prefer LLC’s because they combine the limited liability protection of a corporation with the “pass through”" taxation of a sole proprietorship or partnership.
If the owner(s) of an LLC wish to take advantage of the benefits of the S Corp listed above, they can file with the IRS to be treated as such. And, depending upon the specific situation, there can be additional tax benefits related to the owner’s salary.
LLC’s allow greater flexibility in management and business organization.
LLC’s do not have the ownership restrictions of S Corporations, making them ideal business structures for foreign investors.
LLC’s accomplish these aims without the IRS’ restrictions of an S Corporation.
Summary of differences between Corporation and LLC
Corporation:
When forming a Corporation, your revenue is taxed as a corporation. Which means that revenue is first taxed at the corporate level, then when the remainder is disbursed to the owners, it is taxed again as personal income (commonly referred to as double taxation).
This can be overcome by filing for Sub Chapter S status with the IRS. Once a Sub-S corporation, all revenue is passed through to the owners and taxed at the personal level, just as in a sole proprietorship or partnership
There is an annual paperwork requirement as a corporation. There are some annual meetings required when incorporated, and the associated paperwork must be maintained showing that the meetings were, in fact, held.
LLC:
When forming a single member LLC, for tax purposes the IRS treats you as a sole proprietor. If there are two or more members, the LLC is treated as a partnership. In both cases, revenue is passed through to the individual owner(s), and taxed at each owner’s personal tax rate. Should there be a requirement for the LLC to be treated as a corporation, a Subchapter or S corp, which now allows you to realize some significant tax savings, an additional filing with the IRS can accomplish this.