Congratulations! You’ve decided to start your own business. Whether you’re expanding a side hustle into a full-time gig or growing your team of employees, it’s wise to legally protect your business and your assets. But choosing a legal entity, or legal structure, for your business does more than CYA — it can save you money through tax breaks and exemptions. Here’s how to decide if your business should be an LLC or an S Corp.
First, let’s get acquainted with legal terminology. It’s not as complicated as it sounds. A business entity is your legal structure. Your entity can be an LLC, C-Corp, S-Corp, or sole proprietor. My clients are usually sole proprietors or LLCs.
What’s a sole proprietor?
If you’ve been running a business as yourself, you’re a sole proprietor. Perhaps you’ve filed a DBA — doing business as — or are working under your own name. But you haven’t filed any legal documents outlining your business’ legal structure. The good news? You’re probably saving money by not filing. The scarier news is that you could be exposing yourself and your personal assets, like your home, cars, and bank accounts, to be legally liable. If your business is sued by an unhappy customer, you are personally responsible for all the business’ debts and its liabilities. This means your professional and personal assets are up for grabs. No, thank you!
Being a sole proprietor is risky business regardless of your income.
The better option is an LLC.
It’s right there in the name: limited liability company. By becoming an LLC, your personal assets are protected against creditors. A disgruntled client could sue for your business assets, but your home, cars, and personal accounts would remain untouchable. This is the major difference between sole proprietorship and an LLC.
An LLC can have a single member or multiple members, so this options works for business partnerships.
If you are seriously committed to building a business, it’s worth the nominal cost of setting up and LLC. The cost to create an LLC varies from state to state.
How do I file an LLC?
Visit your state’s Department of State LLC division. In my home state of New York, it costs $200 to file the LLC’s Articles of Organization. This is then followed by placing legal notices in a daily and weekly paper for 6 weeks, then filing an Articles of Publication.
For less than $500 you can have a legal entity set up and remove the worry that your personal assets are at risk. There is a biennial fee you pay as well, and in New York State which is, at the time of this writing, is $9.
So if you take anything from this post, please strongly consider creating an LLC for your business.
What about S-Corps?
An S-Corp is a tax identification, not a legal structure. Having an S-corp status offers major tax savings for businesses with a profit. If your business makes over $50K in net income (think: income minus expenses), you can save approximately $5K/year in taxes. If you are over $100K, that number goes to $10K in savings. But before filing Form 2553 with the IRS, I strongly recommend that you connect with your CPA or ask your bookkeeper to find out more.
If you are an LLC, you can file paperwork (Form 2553) with the IRS to treat your LLC as an S-Corp. Why? Because an S-corp is not subjected to self-employment tax on the profits of the business. Being recognized as an S-Corp for tax purposes means that, as the owner working in the business, you are not considered an owner-employee and thus are required to pay yourself a reasonable salary. Once you file Form 2553, you are considered an owner and an employee of the business. You can still have profit distributions.
Should I file a Form 2553?
Can you pay your owner-employees a reasonable salary? This is the most important aspect. S-Corps are great because they are not subject to self-employment tax. However, before you make profit distributions you must must pay owner-employees a reasonable salary. Like other employees you may have within the company, you will receive a paycheck and your company will be subject to payroll taxes.
While creating your business entity is critical, what’s equally as important is ensuring you’re not co-mingle business banking with personal banking. You prevent this by creating a sound bookkeeping system.
Thanks for reading. Please keep in mind that The Wellness Bookkeeper, LLC and the information contained herein is not intended to be a source of advice with respect to the material presented, and the information and/or documents contained in this website do not constitute legal advice and is not be held liable.