Business Advice

Two of the most popular business structures today are limited liability companies (LLC’s) and sole proprietorships. An LLC is simple to set up and easy to maintain while both LLC’s and sole proprietorships offer various benefits. However, if you are deciding between the two, it is often the case that the benefits of an LLC surpass those of a sole proprietorship.

An LLC is a business structure that is recognized at the state level but has possible federal tax implications. In some ways an LLC mirrors a corporation and in some ways it resembles a sole proprietorship. An LLC is characterized by a flexible business structure, legal protection of the owner’s personal assets, and possible tax advantages.

A sole proprietorship is the simplest business structure. In a sole proprietorship, there is one owner whose personal assets are not distinct from their business assets. It is essentially equivalent to the single owner, and is formed by the act of doing business. There are no state forms or filing requirements other than taxes.

Every business decision you make includes a set of objective facts applied to a subjective situation. In many scenarios, an LLC ends up offering more benefits for a small business than a sole proprietorship, but it always depends.

That being said, some of the typical benefits of LLC’s include the following.

Taxes. When it comes to taxation for LLC’s and sole proprietorships, there are some similarities, but also a few important differences in key categories:

  • Double taxation. Both LLC’s and sole proprietorships avoid the double taxation that corporations undergo; however, depending on your individual tax rates, it may make sense to be taxed at the corporate level.  Always consult with a tax professional. This is because the IRS considers both business structures to be “pass-through entities,” meaning that any business income is reported through the owner’s (or owners’) individual tax return rather than a separate business return. An LLC enjoys this privilege because it is only recognized at the state level as a registered business; federally, an LLC is recognized as a sole proprietorship.
  • S corp filing. A sole proprietorship does not have the option to file as an S corporation, while an LLC can elect to file as a partnership or corporation or be a disregarded entity. Depending on the individual situation, this flexibility may result in overall tax savings for the LLC.
  • Self-employment tax. Both LLC’s and sole proprietorships are subject to self-employment tax, which can be high. However, some self-employment taxes can be reduced for higher wage earners.

Funding. The flexibility of an LLC will encourage funding by investors. An investor will be able to gain ownership interest without the risk of liability. If you plan to expand ownership or get a loan, an LLC will work better for you in most cases.

Formation and Legal Requirements. It doesn’t get easier than creating a sole proprietorship, but LLC’s are also easy to start and maintain. Both require little paperwork, and most states have minimal regulations for operating an LLC (for example, you are not required to have regular shareholder meetings).

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Ownership. This may seem like an obvious difference, but in a sole proprietorship, there is just one owner, whereas an LLC can have one or more owners. There is quite a bit of flexibility allowed by an LLC, since it can be run by either the owner or owners (called “members”), or by managers (elected by members). There are also multiple leadership structures available to an LLC, so you can keep it simple or model it off a corporation with a board of directors.

Liability. This is perhaps the most significant area of concern when it comes to sole proprietorships, and it is often the area where LLC’s carry the most weight in a decision between the two structures. There is potentially a lot of risk associated with sole proprietorships due to the following:

  • Personal loss. A sole proprietorship offers no separation of business and personal assets; this means if you end up in debt or you are being sued, your personal assets can easily be attacked and lost. Even if you have to file bankruptcy, your personal assets will be affected.
  • Termination of the business. If a sole proprietor passes away or becomes unable to run the business, the business will be terminated by default.

To mitigate these concerns, a sole proprietor can purchase business insurance appropriate for their industry. While it can be expensive and won’t solve the issue entirely, it is worth considering if you strongly feel a sole proprietorship is right for you.

Overall, the benefits of an LLC outweigh a sole proprietorship in this area. With an LLC, if you are sued or dealing with debt, your personal assets will be protected as long as you didn’t act fraudulently, unethically, or irresponsibly in the events leading up to the lawsuit or debt.

Your industry. Perhaps if you started a neighborhood lawn care business or work as a freelance blogger, a sole proprietorship will make more sense for you because you don’t have as pressing a need for the benefits of an LLC. On the other hand, if your business carries inventory or you are in an industry that is more likely to be sued (such as construction), an LLC is probably going to be a wiser decision for you.

Your ownership plan. If you plan to bring on partners or hire employees, an LLC typically offers better protection and tax advantages.

Your goals for your business. Owners who wish to expand their business down the line, especially if it’s a long-term expansion plan, should seriously consider forming an LLC.

The bottom line: In most cases, an LLC is going to be a better choice for a business due to the asset protection, flexibility, and tax advantages it provides, but it does depend on your unique situation. Before making any major business decision, it’s best to consult with an attorney first to understand your options and move forward in the best way for your business.

Wondering whether an LLC or sole proprietorship is right for you? Get in touch with one of our business attorneys today. We are business owners ourselves, so we understand how much your business means to you and how important it is to make the best decisions.

Are you wondering if filing as an S corporation is right for your business? Depending on your circumstances and the state where your business is located, filing as an S corporation may be an efficient way to maximize tax savings while offering personal asset protection.  However, with the Tax Cuts and Jobs act of 2017, most of the advantages of filing as an S corporation no longer make sense. 

The plan emphasized cutting the corporate tax rate and simplifying the individual income tax system. Whether a hugely profitable multinational corporation or a sole proprietorship, every business that counts as a C corporation (or C-Corp) is now taxed at a flat rate of 21%, down from the original 35%.  Further, because many LLC owners can deduct up to 20% of their business income before their tax is calculated, it can be highly beneficial to file as an LLC based on an individual’s own personal income tax rate. This could range from 10% to 37% based on each individual’s unique filing status and income level.

An S corporation (Subchapter S of the first chapter of the IRS Code) is a type of business tax status that has similar tax advantages as a partnership or LLC.

If your business meets these requirements, you may be eligible for S corporation filing:

  • Domestic Corporation: Most companies registered as LLCs or C corps are allowed (exceptions include sales corporation, insurance company, or financial institution).
  • Shareholders: The business must have no more than one hundred shareholders, all shareholders must be U.S. citizens, and partnerships and corporations must not be shareholders.

If you live in a state that recognizes S corporation filing, making the switch could be a smart move for your business. Here are some of the advantages to filing as an S corporation.

Potential Tax Benefits (Always consult with your Tax Professional)

In most states (including Kentucky and Ohio), a company that has filed as an S corporation is considered a pass-through entity, meaning that you would file your business and personal taxes together rather than separately, thus avoiding double taxation.  However, under current law, your rates may be lower at the c-corporation level.

Although the corporation would still furnish an annual information return (Form 1120-S) to the IRS, shareholders of the S corporation would report business income on their personal tax returns. 

California, Louisiana, New Hampshire, New York City, Tennessee, and Washington DC tax S corporations differently. Before deciding to go ahead with an S corporation filing, check with your attorney or accountant to make sure you understand how an S corporation will be treated in your state.  Recently, in most cases, filing as an LLC or c-corporation may supply more favorable tax treatment.

Asset Protection

Like an LLC, an S corporation provides limited liability protection for the owners’ personal assets. With this type of protection, personal assets cannot be seized as the result of a lawsuit or court ruling. 

Payroll Savings

Under an S corporation filing, business owners are classified as employees rather than employers. This means they can collect a salary as well as dividend income (or ownership draws).

The leftover income, or dividend distributions after paying for one’s salary, is subject to federal and state taxes, but not FICA taxes, which results in overall tax savings. Business owners or shareholders can distribute the dividend income among themselves.

In other business structures, business owners would be required to pay federal and state taxes on their salary along with the remaining income.

Despite the advantages of an S corporation filing, there are some disadvantages to consider as well.

  • Time and effort. Filing as an S corporation takes a significant amount of time and effort due to the extra steps and paperwork involved. This can make it more expensive at least at the beginning because your legal consultations and tax assistance may cost more up front. Even for existing S corporations, filing taxes is more complicated than for other structures, so be prepared to spend more time on it.
  • Constant monitoring. S corporations are subject to a lot of strict rules and guidelines, so the IRS tends to check them closely. It is particularly important to understand all the requirements beforehand and to keep detailed records to prevent your S corporation status from being rescinded.
  • State laws. Not all states offer the same tax benefits for S corporations. It is best to learn your state’s regulations before making your final decision.
  • Tax Cuts and Jobs act of 2017. In many cases, the tax benefits of reducing some of the payroll taxes attributed to owners and “double taxation” of c-corporations were reduced by the flattened c-corporation tax rate of 25 percent and the 20 percent deduction, in many cases, for owners of LLC’s.

The bottom line: it is important for businesses to look at their structure to make sure they are adapting to the always changing tax rules. Just be sure to weigh the pros and cons of your current corporate structure against the pros and cons of any new structure and gather all the facts before making the leap. And always consult with your tax professional.