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Should I operate my business as a sole proprietor, LLC or a corporation?
The answer to this question mostly depends on your personal financial situation and what your expected earnings will be. Here are some guidelines to help you understand the different structures.
Most people think of incorporation for the limit of liability on their personal assets. The thing you must be aware of is if you, in the course of performing your duties of the corporation, are personally negligent or intentionally did wrong, then you may be held personally liable. Here are some things to consider about corporations:
1) A corporation is an entity in itself. It’s like a person on paper, and it exists separately from those who created it, own it or control it. A corporation has the power to own property, borrow money, transact business and many other things, just as a person can do. A corporation is responsible for its own business relationships and liabilities. This is very important especially when hiring employees.
2) The different tax level brackets set by the IRS can be of great significance depending on your personal financial picture. Your accountant can give you professional advice on which is best for you. The less your annual profit, the tax level structure may not be relevant.
As far as the Social Security and Medicare, normally 15.3% is paid half by the employer and half by the employee. Since you are both, it comes out of your pocket, no matter what. The big difference is if you are a sole proprietor you are subject to pay what’s referred to as self-employment tax (SE) on 92.35% of your taxable income which could be significant if your business does well because the whole profit would be considered your personal income. Here’s an example of that calculation if your business net profit was $50,000:
$50,000 X .9235=46,175 X .153= $7,065
As a sole proprietor the SE tax would be $7,065 since the whole business profit passes through your personal tax return as earned income. A corporation pays 15.3% of only the amount paid out as wages. So if you were set up as a corporation you could allocate only $25,000 as your personal earned income. That would mean you would only owe $3,825 for Social Security and Medicare ($25,000 x .153 = $3,825). Wait - don’t get too excited. Remember - as a corporation, you are an employee. Although you would still be saving a substantial amount, the corporation may be subject to employment taxes that you would not pay if you were the only worker in your business as a sole proprietor. Because of the different variables used to calculate employment taxes and the percentages being different depending on your business profile as well as state and local laws, it is best to ask your accountant and/or governing agencies for accurate rates that may apply to you as a corporation.
3) There are certain items which may be fully deducted by a corporation, but not by an individual; for example, certain medical and insurance expenses.
4) If your company has retained earnings, you may invest that money to earn interest. For corporations, 70% of dividends are excluded from income tax. As an individual, you are typically subject to income tax on 100% of the dividends.
5) Operating as a corporation may have a certain appeal to potential business associates, clients and financial institutions.
Being organized and having a good business plan, whether you’re incorporated or not, is vital to your growth.
Here are some other ways you may form your business (keep in mind not all of these may be available in your state):
Partnership
Limited Partnership
S-Corporation
Limited Liability Corporation
You may form your business on your own; however, it is strongly advised that you seek the advice of your accountant and attorney on which form of organization is best for you. So that you can better understand the professional’s advice you may want to become familiar with the description of each form of business structure in your state and the fees that apply to each. This information is available to you by calling your Secretary of State office. Most states have printed material that you can request which contains the fees and descriptions. If you would like the phone number for your Secretary of State office Click Here.
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