With that in mind, the question becomes whether to form a corporation or
LLC. Of the two entities the simplest to manage is the LLC. LLCs are not
subject to the same formalities and recordkeeping requirements (e.g., annual
shareholder meetings, board resolutions and meeting minutes) as
corporations. LLCs provide pass-through taxation; the net taxable income of
an LLC passes through to its owner(s) and is taxed at the owner(s)'
individual income tax rate. In the case of an LLC with only one owner, the
IRS disregards the LLC for tax purposes and treats the business as a sole
proprietorship. So, at tax time, you would prepare the same Schedule C that
you do now to report your business profit or loss and attach it to your 1040
individual income tax return. And, like sole proprietors, as a
"self-employed" owner of an LLC, you would be responsible for payment of
self-employment tax in addition to income tax. So not much will change by
forming an LLC--except that you would have limited liability protection,
since owners of LLCs are generally not liable for the company
debts/obligations.
Corporations also provide limited liability protection (shareholders are
generally not liable for corporate debts/obligations), but they are taxed
differently. Corporations are taxed at graduated corporate income tax rates
which start at 15% and go up depending on the amount of net taxable income.
And, while corporate formalities and recordkeeping requirements may be
cumbersome for a small business, they may be well worth the time and effort
as corporations can take advantage of certain tax deductions that LLCs
cannot (e.g., certain employee benefits including medical expense
reimbursement plans).
It should be noted that, if you form a corporation, you would need to pay
yourself a salary as an employee in addition to any other employees you will
have. This is because owner-officers who provide services on behalf of a
corporation are considered employees. Employee salaries are subject to
employment tax but any monies paid in the form of shareholder dividends are
not, so you may potentially realize a savings in this regard compared to a
sole proprietorship or LLC (since sole proprietors and LLC owners must pay
self-employment tax on ALL of the net taxable business income). The salary
you receive would be taxable income to you personally but would be
deductible by the corporation as a legitimate business expense.
In addition to federal income tax, most states impose a corporate income
tax as well, so this should be factored in when considering the costs
associated with forming a corporation. Another factor to consider is the
dreaded "double taxation" associated with corporations; income is taxed at
the corporate level, and then taxed again at your individual income tax rate
if/when that income is paid to you in the form of a shareholder dividend. Of
course, many corporation owners avoid double taxation by simply receiving
compensation in the form of a salary only and foregoing any shareholder
dividend payments.
A final note: If both the simplicity of an LLC and the tax treatment of a
corporation appeal to you, you have another option. You may form an LLC and
then make a special election with the IRS to be taxed as a corporation. Your
company would be recognized as an LLC for legal purposes but would be
treated just like a corporation for tax purposes. As I have said in the
past, there is no one-size-fits-all business structure. Bottom line: You
should consult a CPA for tax advice and guidance on selecting an appropriate
structure for your business.
Chrissie Mould
About the PowerHomeBiz.com Guide:
Chrissie
Mould Chrissie Mould has over a decade of experience in business
administration and startup business consulting. She has helped
launch companies in multiple industries and has managed
corporate administration and governance for public and private
companies. She is an incorporation specialist with
MyNewVenture.com LLC. The company provides low-cost
incorporation services to entrepreneurs and small businesses.
Visit www.MyNewVenture.com
to form a corporation or LLC.
