When you’re starting your own business, how do you go about choosing what type of company structure you should have?
**This is a question you should ask your lawyer and tax advisors, not me, however feel free to read my own experience and thoughts to gain insight and questions you can use to ask your advisors for help with.
***NONE of this is actual fact or advice it is my opinion and views of a situation and could be outdated or incorrect and don’t take it as fact without speaking to your own advisors first using this as a question, etc. This site and I are not liable or responsible for any action you take based on reading this etc.
Here are the different types of companies you can choose from:
Sole Proprietorship: The most common business type and what I started with since you don’t need to pay anything to set it up and you can use your own individual tax ID number.
Sole proprietors have to pay all income taxes and self-employment taxes to the IRS. One of the negatives is this type of business does not separate your business and personal income, which is the lowest level of protection.
For example, if someone sues your business, they are also suing you and can sue you for everything you own personally as well as in your business.
Partnership: Same as a sole-proprietorship but two partners/people split the profits and losses together.
Limited Liability Company (LLC): This is the business type I know the least about, however an LLC can be set up as a corporation or a partnership, and how it is structured will influence how much protection it has and how taxes are paid.
Corporation: Includes all corporation types including S and C Corps.
Corporations are great because they separate the business entity from the personal entity, meaning if someone wants to sue your business for all it is worth they won’t be able to sue you personally for all you’re worth at the same time since both are separate entities.
C-Corporation: Cannot pass income and losses onto their shareholders, so if you are a C-Corp you will need to pay the FICA tax on all income that goes to any employees of the company.
From talking to my own tax advisor, I think it is the case that C-Corps can give money to charity separate from the individual as a tax expense, whereas any charity money given by an S-Corp is automatically counted as the individual owner giving the money, not the company, making it easier for S-Corps to max out or not be eligible for charitable deductions.
Double check with your own advisor to be sure for your own situation etc.
S-Corporation: I chose an S-Corporation so I could save on the 15% FICA tax for all money that is more than the salary I pay myself on payroll.
I am the only employee of my company and the primary shareholder, so I pay myself a “reasonable wage”, which seems to be around 50% of company profits, using ADP’s payroll option, and pay my income tax + a 15% FICA (social security + medicare tax) on my payroll money, and then the rest of the profit is still taxed at my income bracket %, but it does not have the additional 15% FICA tax which was the best option to save a little on taxes for my situation at the time.
For example, say your company makes $1,000,000 profit a year as an S-Corp.
Hypothetically you could/would pay yourself $500,000 which would be taxed at your income rate + 15% FICA extra.
Then, the rest of the $500,000 profit would pass through to you as the primary shareholder at the end of the year, and you would pay your income tax, but you wouldn’t have to pay the extra 15% FICA tax on this part of the money!
Here is my own experience and thought process I went through when changing my company from a sole proprietorship to an S-Corp, which I did mostly for tax savings.
One thing I am still thinking about is – should I have an LLC (or C-Corp?) for my websites once I am no longer actively working on them but they are still returning passive income? Because passive income does not require self-employment tax (see below for more detail on that). So that is one question I will be bringing to my tax person soon.
Right now I do technically work hands-on with my sites that are making money so I don’t think they would be eligible, but I do see some of them being eligible to be qualified as passive income with (maybe/hopefully) its tax benefits in the near future.
That is a question I will bring to my tax person soon! If you have advice or experience with passive income and taxes, please feel free to let me know in the comments below.
Two reasons not to become an S-Corp, although there may be many more:
1) If your company is just starting out and not making much profit, then you don’t want to be an S-Corp because there are extra fees including payroll and business docs. AND, most importantly, you don’t even start saving taxes as an S-Corp until you’re making more than what you would live on in a normal salary. So if you’re not making more than what you need to live on, definitely do not start an S-Corp.
2) If you have real estate or passive holdings then don’t start an S-Corp, you’d be better off looking into an LLC, because passive holdings mean you don’t have to pay employment taxes on any of it, and if you put your passive holdings into an S-Corp then you’ll be paying extra unnecessary employment taxes.