By Kristin O’Keeffe Merrick
Originally published on Brit + Co on 2/22/21
There are millions of things to consider when starting your own business. Some of them are very exciting and glamorous–”what cool name should we give our business?”, “what fun logo should we choose?”. Some of the decisions we must make are…not as glamorous but just as important. In this piece, I will focus on the not-so-fun decisions you need to make when establishing your business.
What Kind of Entity Should We Be?
Many new business owners often struggle with how to establish their business. First, I suggest talking to an accountant or an attorney before you make this decision. All businesses operate differently and when you are trying to make this decision, you need to consider what time of business you are running, how many people are involved, and what your personal tax situation looks like. Here are some examples of entities to consider:
Sole Proprietor: If you operate a business on your own and the business is unincorporated, you are most likely a sole proprietor. You are also most likely to be subject to self-employment tax. Sole proprietors need to complete an individual tax return using Schedule C that will serve as a profit and loss (p&L) statement. This will include your income and your expenses. This is where you account for your deductions. You would file by April 15 each year.
Partnerships: Partnerships have two or more people working together in a trade or business. Each person contributes money, property, labor or skill and expects to share in the profits and losses. A partnership must file an annual information return using Form 1065, due when your individual taxes are due. However, profits and losses are passed on to the partners. Each partner then reports their share on their individual returns.
C Corporation: A C-Corp is an entity that is formed under state, federal, or foreign corporation laws. A C Corp has shareholders that elect directors and the directors manage the corporation. The officers and managers hired by those directors carry out the day-to-day work of the business. You must have a registered address and a registered agent. C Corps must pay taxes on any profits earned. C Corps will use Form 1120 and file by March 15. Shareholders pay taxes on any distributed dividends when they file their individual tax return.
S Corporation: An S-Corp must be a domestic business with no more than 100 allowable shareholders. It has only one class of stock. S Corps will file Form 1120S to report any profits. It should be filed by March 15. However, income and losses are passed on to shareholders who will report it on their individual tax return.
Limited Liability Corporation: An LLC is a distinct legal entity that may be treated in a couple of different ways. A single member LLC is treated like a sole proprietor for tax purposes. In other words, you do not need to have an established LLC in order to be a sole proprietor. This is a common misconception. An LLC may choose to be treated as a partnership or as a corporation. In the case of the corporation, it would follow the same tax guidelines as a C Corp.
Choose Your Calendar Year
This is a weird one, but you should think about it. If you run a normal Jan 1st-Dec 31st year, then good for you! If not, you are running a fiscal year (12 consecutive months that doesn’t start on Jan 1). There is also a 52-to-53-week tax year. This is a fiscal tax year that varies from 52 to 53 weeks but does not have to end on the last day of the month.
You May Need an EIN
EIN stands for Employer Identification Number. It is generally not required unless the business is incorporating, operating as a partnership and has employees. In order to obtain an EIN, you can sometimes do this online or through an accountant or an attorney.
Finally, I want to reiterate that if you are the sole proprietor, you do not need to become an LLC for tax purposes. The functionality of a sole proprietor LLC is to protect you from liability. There is not a tax benefit to it. You will consider an LLC if you desire liability protection and/or you have a partner. You should always consult an accountant or an attorney before incorporating and don’t forget that you can always change the way your business is set up on your journey.