If you are in business for yourself, do it as a small business LLC.
Disclaimer: I’m not an attorney, so don’t make the mistake of taking the following as legal advice. It’s really a smart idea for you to seek competent legal and tax advice for your particular situation before starting your company.
There are four basic options you have when you form your start-up:
- Sole proprietor
- LLC
- C-corp
- S-corp
For most people, the LLC is the way to go – assuming you won’t be inviting other people to invest in your small business start-up. If you do, you have to factor in the liability of partners and perhaps consider some other form of entity.
Of course, all four choices have pros and cons. But as you’ll see in a moment, the LLC is very attractive for the right business owner.
Sole proprietor has a huge advantage – it takes no time or money to set up. So if you’re really lazy and don’t care about protecting yourself or your business, go that way.
However, if you do care about protecting yourself and your business, keep reading.
An LLC is super easy to set up and costs very little, especially if you use a company like LegalZoom. The big win here is that even though it’s not a corporate entity, it’s a separate entity from yourself and helps protect your assets.
LLCs are really cheap to maintain too. You don’t have to deal with the complicated bookkeeping, tax filings and other regulations that the C-corp demands. Need more convincing? Members of the LLC are taxed – not the entity. This is huge if you’re a start-up. Why?
Well…start-ups often lose money. If you do and your business is formed as an LLC, you can pass that loss straight through to your personal return. If you form your start-up as a C-corp, it will pay tax on its income and then you will pay tax on any distributions the C-corp pays out to you. Rather stinky.
In other words, if you are a C-corp the company is a tax-paying entity – it pays tax on all income. Then, if the company pays you, you pay personal income tax, that is, money coming into the company is taxed twice by the time you get it. The C-corp form also requires you to have a board of directors and maintain books and records. It’s a paper nightmare.
Another option would be the S-corp. This is just a special kind of C-corp. You get the protection of the C-corp and the tax pass-through benefit of the LLC. (Also keep in mind that the S-corp requires different tax forms than the LLC. And at least for now, distributions of profit aren’t subject to the self-employment tax…for now.)
You do have to deal with the regulatory requirements and you have to be careful as to who you admit as shareholders.
For most business start-ups, the LLC is the way to go. And if you qualify, a Professional LLC is even better. They are a snap to set up, help you avoid double taxation and are cheap to maintain.
Tami says
July 7, 2010 at 6:48 AMMy husband is in construction and he has an LLC. He works for other companies who pay him, not salaried. He then pays taxes on what he earns. Twice this year he has been out of work. The first time was for 8 weeks. We depend on a paycheck every week to get by. He could not collect unemployment because he was an LLC. This was devastating to us. Do you have any suggestions? Can he receive unemployment from being a corporation?
Mike Piper says
July 7, 2010 at 9:18 AMTami, my understanding is that eligibility rules for unemployment benefits vary from state to state. What state are you in?
Khaleef @ KNS Financial says
July 2, 2010 at 1:41 PMWhen I started my business, I did it as an LLC because everything that I read about the differences made me feel it was the best option.
Because they can be treated as a disregarded entity for tax purposes, owners are protected much more than a sole proprietor and they seemed very easy to set up.
One thing I noticed about the limited liability is that if you attempt to establish any type of financial relationship – from bank accounts and credit cards, to credit accounts at office supply stores – they require the owner to cosign for the LLC!
I guess what pushed me over the edge – since I didn’t have any guidance – was knowing that some huge companies are set up as LLC’s (such as Amazon.com).
Nunzio Bruno says
June 29, 2010 at 4:07 PMIn reading the post and through all the comments I think the biggest point to get across to the newly inspired entrepreneur is to get organzied. Regardless the structure you choose the important thing is the plan and understanding the legal framework you choose to operate in. Great commentary and I’m glad to see that a post on LLC’s could generate this kind of interest 🙂
justin goodman says
June 29, 2010 at 7:01 AMI would love someone to post a guide on starting an LLC.
Anthony says
June 29, 2010 at 5:01 AMRespectfully, I must disagree with several of the points made.
First, the analysis of available business forms should be separate from the classification for tax purposes. For the solo business owner, generally there are three choices of form: sole proprietorship, LLC, and corporation. Then, depending upon the form chosen, there’s tax classification: sole proprietor, C-Corp, and S-Corp. The business form chosen dictates which of the tax classifications is available: A sole proprietor is taxed as such; a corporation may choose between the two corporate classifications; an LLC may pick any of the three.
Second, the notion that forming an entity protects assets is overblown. Regardless of the form chosen, insurance is an owner’s best protection. Why? If an LLC or a corporation is inadequately capitalized, a plaintiff may seek to “pierce the corporate veil” (also available against LLCs), going after the owner’s personal assets.
Third, the notion that LLCs are easier to set up and are less expensive to maintain than corporations is, in my opinion, misguided. Both LLCs and corporations are relatively easy to set up; however, setting up an LLC *correctly* is far more complicated. Why? Corporate law has existed for hundreds of years; this has given the law enough time to come up with a set of default rules that cover situations not explicitly set out in a corporation’s operational documents. LLCs only started in the 1970s, and as a result, default rules are lacking. I would not be bothered by a corporation with less than ten pages of operational documents; I’m still leery of an LLC with twice as many.
Fourth, the notion that a corporation has to be more formal than an LLC overlooks most state’s statutory close corporation statutes, which allow owners to abolish corporate formalities (e.g., a board of directors).
Really, the only advantage of an LLC to another form is its ability to elect any of the three available tax classifications. As this election may only be changed every five years, and as setting up an LLC correctly is significantly trickier than either of the other two options, I believe that LLCs are actually the worst of the three forms for the DIY business owner.
Neal says
June 29, 2010 at 5:20 AMAnthony,
Thanks for your reply. Your points are helpful and informative.
Your first point is an excellent broadening of the conversation — I have to look into your point further.
Your second point is something I struggle with. I just have no idea how much protection any legal form has but I know that the protection aspect is one huge reason people consider these options. That’s why I made the point.
Third and forth points….When I started my company, I did so as an S-corp. My experience is that it was indeed a pain in the rear and continues to require work on an ongoing basis. Not sure the LLC requires so much effort. My research says it doesn’t but if you have more info, I’d love to have you share it.
I really appreciate your points. Very helpful Anthony.
Anthony says
June 29, 2010 at 12:28 PMDear Neal:
I may also have been cranky in my pre-coffee hours.
In my work, I encounter LLCs fairly regularly, and rarely are they actually properly set up. Generally this is because an owner did it themselves and missed something (though this is also sometimes the case with an attorney-assisted LLC). Since I think it is more difficult to miss something essential with a corporation, hence my preference (if one needs to form an entity at all).
On the point about liability limitation, I don’t know what to say, aside from anecdotally: I have yet to encounter an LLC where I couldn’t reach the owner’s personal assets. Your state’s LLC statute may be more forgiving.
As far as points three and four go, I will have to follow up with sourcing, though I will endeavor to shortly (my father is coming to town for a visit).
Thanks for taking my commentary in the spirit in which it was intended. And thanks for your blog.
Best regards,
Anthony
Financial Samurai says
June 29, 2010 at 1:40 AMThanks for this Neal! Can you tell us more about the S-Proprietor? Sounds easy, but sounds bad. What are the benefits of a S-Prop?