Determining Your Business Structure
There are so many different ways to legally structure your business. And this list is not all-encompassing, but includes the most common for those wanting to start a handmade business.
I’m going to be very honest with you. This was very confusing to me when I first started and just trying to figure it out made me want to quit! But I knew if other people had figured it out already, why couldn’t I???
So don’t get overwhelmed, this is doable. But only YOU can take the action. You can consult a trusted accountant to help you determine which business structure is best for you at this stage of your business.
When I consulted my accountant in the beginning, it was recommended that we not worry about structuring a business at first. Then once my business grew, it was suggested I form an LLC, and once I grew even more, I was advised to form an S-Corp.
Sole Proprietorship
The sole proprietorship is the simplest type of business to establish, but it is not a legal entity, meaning the law does not distinguish between the owner’s personal assets and the business’ obligations. Once an individual starts selling goods or services, he or she by default creates a sole proprietorship. For example, if you start selling your handmade wreaths on Etsy or a website, you’ve created a sole proprietorship. This sole proprietorship is not legally separate from its owner.
Reasons to Choose a Sole Proprietorship:
The owner can establish a sole proprietorship instantly, easily and inexpensively with very few ongoing formalities. If you’re working on a side project or doing a bit of consulting work, a sole proprietorship could be a good option.
Reasons to Avoid a Sole Proprietorship:
The owner is subject to unlimited personal liability for business debts, losses, and liabilities. For example, if your wreath business goes into debt, your personal assets could be at risk. Also, obtaining capital, such as a bank loan, can be more difficult as lenders often require a more formal entity structure. However, taking out loans for your business should be way down the road and done sparingly.
Who should choose a sole proprietorship?
A sole business owner who is willing to accept complete responsibility for the business’ liabilities, as well as its income. The owner will be financially responsible for the business’ debts, expenses and payable and creditors can garnish the sole proprietor’s personal income if the business falters or fails. A sole proprietorship is good when you’re starting out and perfect for testing ideas, but it’s not a good long-term solution.
Limited Liability Company (LLC)
LLCs were created to provide liability protection that corporations enjoy without the double taxation, which is when there are taxes for both business assets and personal assets. An LLC is like a combination between a sole proprietorship and a corporation.
An LLC taxed as sole proprietorship is a business structure that has the tax advantages of being a pass-through entity, which means its profits ‘pass through’ the business to the LLC members, so they can report profits on their personal tax returns rather than filing a corporate tax return. LLC members must pay self-employment tax on their income.
Reasons to Choose an LLC:
LLCs offer the liability protection without some of the formalities of a corporation. They also tend to be less expensive to set up. The structure offers even more attractions than an S corporation since there’s no limit to the number of members in an LLC.
Reasons to Avoid an LLC:
Depending how the entity elects to be taxed, you may have to pay self-employment tax on your share of the draw (owner’s draw means when you use company money for personal use). Ongoing filings and fees to stay compliant and LLCs can’t go public.
Who should choose an LLC?
This adaptable structure is popular among businesses that are just starting out and not totally sure how much they will grow in the first couple of years.
Limited Liability – S Corporation
S Corporations were created to encourage small and family business creation by eliminating the double taxation that conventional corporations are subjected to. Unlike single-person LLCs, all S corporations must file a S-Corp tax return.
The S corporation, also known as the subchapter or small business corporation, is a tax code that was created to encourage small and family business creation while eliminating the double taxation of conventional corporations.
To become an S-corp, your business first must register as a C corporation or LLC.
In an S-corp, the business owners are called shareholders. As an owner, you are considered an employee of the business and must pay yourself a reasonable salary. An S-corp’s profits, losses, deductions and credits are taxed at the shareholder level.
An S corporation is not a type of business but instead a type of tax election.
Reasons to Choose an LLC – S Corporation:
S Corporations enjoy pass-through taxation and shareholders are typically not personally responsible for business debts and liabilities. Limited Liability – S Corp. gives potential tax savings without the additional paperwork and structure of a standard S corporation.
Reasons to Avoid an LLC – S Corporation:
S Corporation may not have over 100 shareholders and those shareholders must be US citizens or legal residents of the United States. Ongoing filings and fees to stay compliant.
Who should choose an LLC – S corporation?
An S corporation is a great option for a business owner who’s looking to pay themselves a salary. It will reduce the social security and Medicare taxes that they pay by making them an employee of the business. Unlike an LLC – sole proprietor, an S corporation does not provide pass-through taxation.
C Corporation
Ownership in a C corporation, usually called a corporation, is expressed through the issuance of shares, while the management of a corporation is governed by a board of directors, who are elected by the shareholders.
The board of directors select officers who manage the day to day activities of the corporation; the officers sometimes own the business. The board of directors will draft bylaws for the corporation, which are basically written protocols that define the way the corporation will be governed.
Corporations are required to hold annual meetings for both the shareholders and the board of directors. The annual meetings are held to discuss and decide on important decisions that are faced by the corporation.
Reasons to Choose a C Corporation:
C Corporations can have an unlimited number of shareholders and ownership is easily transferable through the sale of stock.
Reasons to Avoid a C Corporation:
C Corporations may incur double taxation on corporate profits.
Who should choose a C Corporation?
An entrepreneur planning to raise a large amount of money from venture capitalists or take the business public.
Disclosure – this is my best understanding of the different business structures. You should consult your own accountant or tax advisor to determine the best fit for you and your family. What works for one handmade business, may not be the best solution for you.