Small Business Basics: Entity Formation
There are several forms your business can take: You can be a sole proprietor, d/b/a (“doing business as”), partnership, LLC, or corporation, among others. There are pros and cons to each, but first you should have a basic understanding of what each of these mean.
If you do not incorporate (form an LLC or corporation), and you just start doing business, then you are a sole proprietor by default. If you get together with another person and conduct business together, then you are a partnership. You don’t have to do anything, you just are. As a sole proprietor or partnership, any income to the business is simply income to you and is taxed at the individual rate. If anyone had a claim against you they could sue you personally, and you would be required to pay any judgment (putting insurance aside for the moment).
d/b/a is an abbreviation for “Doing Business As.” If you are a sole proprietor (you are in business but have not incorporated a business entity), you can operate under your own name, or you can have a business name. If you operate under a business name, then you are a d/b/a.
C-Corp and S-Corp
Another way to engage in business is to incorporate. The traditional way to do this was to form a corporation. A traditional corporation is not going to be a good choice for any most small businesses, because the rules are more complicated and corporations are subject to an additional tax. There is an alternative referred to as an S-Corp. If your business is bringing in more money than you want to pay yourself, then you should consult with a tax accountant or a lawyer and decide whether S-corp status would be good for you.
Limited Liability Company
Most of my small business clients are choosing between being a sole proprietor (perhaps operating as a d/b/a) and an LLC. There are pros and cons to incorporating an LLC. The cons are that it costs money to set up, and effort to maintain, and if you don’t maintain it correctly, then it is not going to bring you much if any benefit. The benefits are asset protection, an appearance of professionalism, and the ability to transfer ownership.
Lawyers love LLC’s because they combine the best of sole proprietorship/partnership and corporate status. They are treated for income tax purposes the same as your individual income. As they say it’s passed through the LLC to the you, the owner, no corporate-level tax. They are relatively easy to set up and maintain. And they give you the asset protection of a corporation. However, depending on what type of business you operating, the asset protection may not provide as much protection as you might think, and the cost and effort of maintaining the LLC may outweigh the potential benefit.
If you want to know more about whether an LLC is right for your business, feel free to contact me at firstname.lastname@example.org