Types of Businesses
The are several types of business that can be started: Sole Proprietorship, Limit Liability Corporations (LLC), Small Business Corporations (S-Corps), or Corporations (C-Corp). For all of my personal and business needs, I use Legal Zoom. They generally charge several hundred dollars plus state fees to set up an LLC. Some states, like Ohio, have small business sites that help you complete all the documents for free plus a filing fee. The primary document for creating any business is the articles of the organization. This describes how the business is governed and who is in charge. Sites like Legal Zoom help you form more complex articles of organization. In the beginning, these advanced articles are not needed, but later, you will need them, such as in estate planning. It usually costs $100 or so to re-file articles if you change them. Before diving into each of the types of business, several key terms need to be explained, such as Employer Identification Number and Registered Agents.
Employer Identification Number (EIN).
An EIN is a Federal Tax ID for a business. It is like a social security number for the business. This is important because it is necessary for business bank accounts and is often used in other business documents. Business trade EINs to make sure all the appropriate tax documents/profits/etc. are recorded with the federal government. Each business you work with will require a W-9. Also, an EIN is necessary to pay employees. Do I really need to pay taxes on my business? Yes, you could face thousands of dollars in back tax fees and interest. In future posts, we will deal with accounting, taxes, and tax returns. Most likely, your first business actions will require an EIN. You can get an EIN online from the IRS for free. It is relatively painless.
Registered agents are businesses or people who offer an official point of contact for your business. These are companies like Legal Zoom, Incfile, or your lawyer. You don’t need a registered agent if you have a stable brick-and-mortar address, and it is located in the same state as the business. A registered agent ensures that you get the official mail. Sometimes they will even process it for you. This is key because you may receive time-sensitive material necessary to keep the business or be served legal documents. An example would be an article of organization renew notice. Register agents generally charge $150/year.
4 Types of Businesses
Sole Proprietorship (SP)
The sole proprietorship is the simplest type of business to form. For this business, you need to register your business name with a state. A sole proprietor is the single owner of the business and the only one allowed to make legal decisions. An SP business is a legal entity. As a legal entity, you can register with the federal government for an EIN. An SP is a real business and has the same legal standing as any of the more complex businesses below. Often people assume you have to be an LLC to be a real business. Not True. SPs can have employees, tax-deductible expenses, bank accounts, etc. SP profits and losses are recorded on your personal tax returns on Schedule C or E. To form a sole proprietorship, you need to file a Doing Business As(DBA) form with the state government. This can be found online or at any of the services listed above. For tax purposes, an SP is considered a disregarded entity. This means that you can claim it on Schedule C on your 1040 tax form.
Single Member Limited Liability Corporation (S-LLC) & Multi-Member LLC (LLC)
Sometimes an S-LLC is also called a sole proprietor LLC. To avoid confusion, we will call it a single-member LLC. What is an LLC? This is a legal entity that separates the individual’s assets from the business’s assets. This provides legal protection of one’s personal assets from the businesses. Say the business gets sued, goes bankrupt, etc., your personal assets are not touchable. On the other hand, a personal lawsuit can affect your LLC. An S-LLC is like a sole proprietorship, except it has another document called articles of organization. IN an S-LLC, the owner makes all the legal decisions for the business. Also, S-LLC is considered a disregarded entity by the federal government. This allows the owner to file taxes on their personal tax return with a Schedule C or E, just like an SP. Multi-member LLCs are like an S-LLC, except for the articles of the organization must include the members and % ownership. It also should include how decisions are made and procedures for adding or removing members. For tax purposes, most of the time, the multi-member LLC needs to file taxes like a partnership, Form 1065. Laws get more complex as spouses and/or trusts are added to the LLC. LLC may have employees. Employees are required to be paid “reasonable salaries.” All salaries are subject to social security and medicare tax paid in part by the employer. Owners are not considered employees of an LLC. All LLCs do not have to pay taxes on the profit. This is passed to the individuals because LLCs do no have officially have retained earnings.
An S-Corp or small business corporation is a legal entity that provides some tax advantages. The profits are not taxed as income for the corporation. They are paid out as dividends. But, the s-corp must pay owners a “reasonable salary,” and any profit-taking is taxed income. It is required that S-Corps have employees (at least the owner). As with above, the employer is responsible for social security and medicare taxes in-parts. S-corps add another layer of complication. An S-corp needs professional legal and accounting consulting. For more information on the tax savings that S-Corp offers, see Nolo.
This a business in every sense of the word. The business profits are taxable. It has employees and the Corporate board. The C-Corp offers dividends to investors and the like. Several tax strategies might make sense to form an S-Corp or C-Corp.
Do I need an LLC/Corporation?
What are you trying to protect? I have seen extremely complex business structures. For example, one setup included 4 separate LLCs owned and managed by a C-corp. The individual set up each of the 3 LLCs to hold a future property; the fourth was set up for a possible cleaning company. The C-corp captured business and legal expenses for overall setup and management. While this sounds very “sophisticated,” each of these businesses did not own any assets or turn profits. The LLCs/corporations were not protecting anything; they were racking up business expenses.
The goal of a lawsuit is to get money. If you do not have any assets, personal or business-wise, there is very little to be lost, and you are unlikely to be sued. If you have personal assets but few business assets, a single LLC will protect the personal assets from business lawsuits. If you own, i.e., no mortgages, several properties, then a separate LLC for each might be necessary. In this case, you would look to a structure in the example above. At this point, you are probably a million-dollar corporation and have a corporate lawyer and an accountant to give you advice.
If you don’t have many personal assets, a sole proprietorship is the way to go. They are the cheapest and easiest to manage. Otherwise, I would recommend a sole proprietorship LLC to start with. It is important to establish a business. See the post Step 1 – Starting a Business for more details on why. When deciding on the type of business to start, the cost is always a major factor, so do your homework. If you can afford it, I highly recommend using a service like Legal Zoom. They greatly simplify the processes.
Hopefully, this gets you thinking about starting your business. As always, feel free to post your questions or comments below.
If you found this series useful, please share it on social media using the buttons below. Don’t forget to sign up for our monthly Newsletter, Special Hot Tips, and our free gift delivered to your inbox!