As I work on the second aspect of my business – Advertising and Marketing, I want to address the third area – Legal and Taxes.
Mention the words legal and taxes and most people either run away screaming or start to panic. Legal usually conjures up images of shyster lawyers or being sued. Taxes rarely evokes positive thoughts. As it relates to your business, legal and taxes are two critical issues you have to get right. Not only for the short term, but for the life of your business as it grows and develops.
In creating my business, those two terms go together. After deciding on a business name, JClouse Business, I had to decide how I wanted to structure my business. When I say structure my business, I mean choosing the type of business entity I was going to operate. There are 10 types of business entities you can choose from:
- Sole Proprietorship
- General Partnership
- Limited Partnership
- Limited Liability Partnership
- Limited Liability Limited Partnership
- Limited Liability Company
- Family Limited Partnership
- Subchapter “C” Corporation
- Subchapter “S” Corporation
- Professional Service Corporation or Professional Liability Company
When you are selecting a business entity, you need to considering the following key areas:
- Number and relationship of principals (those people primarily running the business)
- Intended present ownership and desired management structure (who will own the business and who will manage it)
- Present and future business plans
- Protection of business and personal assets
- Size of investment and growth potential
- Availability of third party financing
To begin, I needed clarity on what I am doing. I started a for-profit business that conducts affiliate marketing via the Internet with no fixed business location, no real property, and no inventory or tangible property to sell. I am the sole owner and the only one operating my business.
Next, I needed to decide on the type of business entity I wanted to setup. I eliminated those entities that did not apply. Since I am the sole owner/operator, the Partnerships were not applicable. Since this is not a professional business, such as lawyer, doctor, accountant, etc, the Professional entity was also not applicable. That left Sole Proprietorship, Limited Liability Company, and Subchapter “C” and “S” Corporations.
A Sole Proprietorship is a business owned by one person.
- A sole proprietor has unlimited liability. They are liable up to the entire amount of their personal and business assets for the debts of the business.
- This is the easiest type of business to setup since no agreement or filing is required with your state or local government to create and operate the business. It is normally operated under the real name of the owner.
- You can also create a fictitious name and operate your business under that name rather than your real name. However, if you choose to operate your business under a fictitious name, you need to file a Certificate of Assumed Name with the county clerk in the county you maintain your principal business.
- The business is taxed as a pass-through entity for Federal income tax purposes, which means the business does not file a corporate income tax return with the IRS. Instead, once the business has paid its expenses and debts, the owner pays tax on any remaining revenue (the income “passes” directly to the owner). The owner must report income and business expenses using Form 1040 Schedule C on their individual income tax return.
A Limited Liability Company (LLC) is a hybrid entity and can be used by a single person for their business or by diverse owners of a larger business.
- Before you start, you need to make sure the business name is available by going to your Secretary of State’s website and conducting a name search.
- All LLCs are managed by either the owner(s) (member managed) or by a manager(s) elected by the owner(s) (manager managed).
- An LLC is formed by filing Articles of Organization with your state’s Secretary of State’s Office and is available in all states.
- You do not have to create and file an Operating Agreement, but it is recommended if it is a multiple owner LLC.
- You normally must designate an individual or other domestic agency as the Registered Agent.
- An advantage of an LLC is in its name – Limited Liability. This means that absent fraud or other exceptional circumstances, a debt, obligation or other liability of the business is solely that of the business. A member or manager is not personally liable, directly or indirectly, for that debt, obligation or liability. The liability is limited to the assets of the business.
- It is taxed like a partnership or sole proprietorship (pass through) for Federal income tax purposes but operates like a corporation. The business does not file a corporate income tax return with the IRS. Instead, once an LLC has paid its expenses and debts, the LLC owner(s) or members pay tax on any remaining revenue for their share of the business.
- A single member LLC will report income and business expenses using Form 1040 Schedule C.
- A multiple owner LLC is taxed as a partnership. Members receive a Schedule K-1 from the LLC, and transfer that information to Part II of Schedule E and any other forms indicated on Schedule K. These forms are then filed with Form 1040.
A Subchapter C Corporation is a separate legal entity and as you can imagine, has a lot more requirements for formation and operation.
- Before you begin, you need to make sure the corporation name is available by going to your Secretary of State’s website and conducting a name search.
- The corporation is formed by filing Articles of Incorporation to the Secretary of State.
- You must designate an individual or other domestic agency as the Registered Agent.
- To complete the forming of a corporation, the incorporators (those who established the corporation) must have an organizational meeting. At this meeting officers will be appointed, bylaws will be adopted and any business mentioned in the meeting will be carried on.
- The most important part of incorporating is to document the actual issuance of shares and identify who the shareholders are.
- If a married couple forms a corporation, there needs to be a record of whether the shares are acquired individually or as tenants by the entirety.
- There is also record keeping requirements such as articles of incorporation, written communication to shareholders, minutes of all meetings, and annual report, among others.
- The name Subchapter C Corporation comes from Subchapter C of Chapter 1, Title 26, United States Code that contains the primary tax provisions affecting basic corporations. Corporations are taxed at lower rates than those generally applicable to individuals. However:
- The minimum corporate tax rate is often higher than the maximum individual tax rate because of double taxation imposed on Sub C Corporations.
- First, the corporation income is taxed at the corporation’s rate.
- Second, any distributions to shareholders are subject to income tax and the shareholder’s tax bracket rate.
- The “pass through” feature is not applicable to Sub C Corporations.
- Business losses are trapped at the corporate level and will only be of benefit when the corporation becomes profitable.
- Business losses from the corporation cannot be deducted on the individual shareholder’s return.
- Thus Sub C Corporations are generally less desirable when considered from a tax perspective.
- Sub C Corporations must also file a U.S. Corporation Income Tax Return to report the corporation tax, and each shareholder must file their individual income tax return to report their personal income tax.
A Subchapter S Corporation provides an alternative corporate form taxed similarly to a partnership.
- Before you begin, you need to make sure the corporation name is available by going to your Secretary of State’s website and conducting a name search.
- To be a Subchapter S corporation, you must be a small business, which is having 100 or fewer eligible shareholders and have only one class of stock.
- The corporation must be a domestic corporation, which is created or organized in the United States under the laws of the U.S.
- A Subchapter S Corporation election is made by filing Form 2553 with the IRS.
- Like a Sub C Corporation, the formation requirements for a Sub S Corporation are similar:
- The corporation is formed by filing Articles of Incorporation to the Secretary of State.
- You must designate an individual or other domestic agency as the Registered Agent.
- To complete the forming of a corporation, the incorporators (those who established the corporation) must have an organizational meeting. At this meeting officers will be appointed, bylaws will be adopted and any business mentioned in the meeting will be carried on.
- You need to document the actual issuance of shares and identify who the shareholders are.
- If a married couple forms a corporation, there needs to be a record of whether the shares are acquired individually or as tenants by the entirety.
- There is also record keeping requirements such as articles of incorporation, written communication to shareholders, minutes of all meetings, and annual report, among others.
- The name Subchapter S Corporation comes from, as you guessed it, Subchapter S of Chapter 1, Title 26, United States Code:
- The tax impact of business operations are passed through directly to the shareholders and reported as separate items of income, deduction, credit and loss. This is beneficial for small businesses as they often sustain losses during the early stages of operation.
- The income of a Sub S Corporation will generally not be taxed at the corporate level because it is passed through and taxed solely at the shareholder level, eliminating double taxation.
- The same applies for corporate level deductions and losses.
- However, a Sub S Corporation is not completely immune from corporate level taxes. Applicable corporate level taxes include the built-in gains tax (if a C Corp becomes an S Corp) and the “sting” tax on excessive passive investment (if gross passive investment income (interest, dividends, etc.) exceeds 25% of gross receipts, the corporation may be subject to tax on its net passive investment income (gross passive investment income minus expenses of earning that income).
- A Sub S Corporation is generally more desirable when considered from a tax perspective.
As you can see, while I reduced the options of business organizations to four, I still had a lot to consider in choosing the right one. Since this is already a long general overview post of these four types of businesses, I will end here. I will discuss what business type I chose, and how, as well as the steps required to create it, in next week’s blog post. These are rather lengthy posts because the formation of a business, especially anything other than Sole Proprietorship is a lengthy process requiring patience.
I know there is a lot of information on the Internet about business types and how to create them. There is also a lot of bad information out there so beware. I am presenting this as a general overview so you understand the differences and can do more research on your own to determine which is best for you. This Blog is for you – to help you achieve success in your business. I had a lot of questions about this topic when I first started and wish I knew this then.
This post is not legal or tax advice, rather, it is information readily accessible in legal, public and tax records, and applicable to the United States only. I compiled that together in a single post. Am I an expert in this area? No, not yet. I have a Bachelor’s of Business Administration Degree with Finance major, I have prepared Schedule C business tax returns for over 20 years, and as a lawyer I am licensed in Texas and Florida and a member of the Florida Bar Tax Section. You are certainly free to confirm anything I say in this post or any other post. Due diligence is always good. I do not mind 🙂
If you are not already signed up to get my newsletter, I invite you to join so you can get the latest updates and detailed information only for those Voyager Newsletter members. You can join here. I welcome you to keep navigating my voyage with me and tune in next week to see how I chose my business type and the steps I took to organize and start my business. I will see you soon!
Excellent and thorough summation of the ins and outs of growing a business. I’m sure we can all glean important tidbits from what you present here. You are correct-discussion about taxes is akin to discussing death itself. But as I describe on my blog today, we are better when we discuss these important topics.
Thanks, Kate. I’m just trying to share what I went through in hopes of helping others. Many may choose not do anything other than sole proprietorship, which is great. But for those who do, perhaps this will help them.
Great post! It’s refreshing to see such a detailed breakdown of the different business structures. Legal and taxes can definitely be intimidating, but you’ve made it so much easier to understand. I love how you lay out the pros and cons in a simple, relatable way—especially for people like me who find this stuff overwhelming! Looking forward to seeing which structure you choose for JClouse Business and learning more from your experience. Keep these helpful posts coming!
Thanks, Sarah. I have the same comments about your posts – you lay them out so well and they are easy to understand. If what I share, especially on this topic, can help people, then I have succeeded.
Jordan, Thank you for sharing such a detailed and informative blog post about the legal and tax aspects of starting a business. I really appreciated how you broke down complex topics like business structures into manageable pieces. Your clear explanation of different business entities, especially the distinctions between Sole Proprietorships, LLCs, and Corporations, really helped me understand the choices available when setting up a business. I think things are pretty similar here in the UK.
Thank you for sharing your knowledge and personal experiences. It’s motivating to see how you’re navigating this complex world, and it inspires me to stay informed and proactive in my own business journey. Wishing you all the success as you continue building JClouse Business! I look forward to your next post on the business type you chose.
Thanks,
Atif
Thanks, Atif. I truly appreciate your comments. You’re one of my inspirations in Beginners Advantage. It’s hard enough figuring this out in the US. I was not even going to attempt to figure this out for the UK. Nice to know it is similar.
Hi Jordan,
I really like how you broke down the different types of business entities in a clear and easy-to-understand way. The topic of legal and taxes can often be overwhelming, but your explanation makes it feel much more approachable.
It’s important to consider the structure of your business early on, and I appreciate how you highlight key factors to keep in mind, like ownership, management, and liability protection. Your step-by-step guide for selecting the right entity is very helpful, especially for someone just starting out.
Looking forward to Part 2 and learning more about how you made your final decision on which structure to choose! Thanks for sharing this valuable information!
Meredith
Thanks, Meredith. I didn’t want others to struggle with this area like I did if they are thinking about doing this. As I said a few posts ago, I hope to use my legal knowledge to help others on this journey if possible.
Jordan,
As a CPA myself you are talking my language. I expect in my lifetime I have prepared 10’s of thousands of returns. The most common I see for businesses are a combination of LLC being taxed as an S-corp. I just finished filing season on October 15.
Thanks, Scott. Nice to hear from someone experienced in this field as well. My hope was to make this easier for people to understand.