Deciding what type of business structure is best for your situation

Can Corporate and LLC Structure Protect Sole Proprietors’ Assets?

Deciding what type of business structure is best for your situation

Where are plenty of advantages to being your own boss, but that doesn’t mean that every decision is easy or straightforward. One of the first things you’ll have to decide is the type of business structure that is best for your situation. While selecting “sole proprietor” may seem like the path of least resistance, if you have personal assets at risk for your business’ debts and liabilities, it may make more sense to go with the more complicated route of electing to form as a C- or S-corporation, or even as a limited liability corporation (LLC).

 

See Relax Tax’s Debt Guide at relaxtax.com/debt

 

What is the difference between each?

In a nutshell, if you set up as a C corporation – the preference of venture capital investors – you’ll have to pay taxes as both an individual and as a corporation. By contrast, both S corporations and LLCs have the advantage of a favorable pass-through tax treatment while still providing your personal assets with significant protection.

 

See this related post from Dennis Harabin: Requirements for Reasonable Compensation in S Corporations
Unlike a C corporation, which itself pays the tax on its taxable income, an S corporation does not directly pay taxes on its income; instead, its income, losses, deductions, and credits flow through to its shareholders’ individual tax returns on a pro rata basis. These distributions are not subject to self-employment (Social Security and Medicare) taxes. As a result, many S corporations ignore the requirement that each shareholder-employee must take reasonable compensation in the form of W-2 wages in exchange for services performed for the corporation. These wages are subject to Social Security and Medicare taxes (which the corporation and the employee generally split equally); the corporation is also responsible for paying the Federal Unemployment Tax (as well as any state unemployment taxes).

 

No matter which entity you choose, you won’t find the process costly or complicated, and if you decide to switch at a later date you can do so easily. Still, it’s important to understand that filing a Certificate of Incorporation does not entirely protect you from personal liability. In order to provide yourself and your shareholders with the highest level of personal protection make sure that you do the following:

  • Never use your personal name or the name of a shareholder on any official documents. Whether invoices, correspondence, or contracts, the official corporate name is the only appellation that should be used, and the word “inc.” or “corp.” should be included where corporate. This is the best way to ensure separate entity recognition. The same is true whenever signing on the company’s behalf. Only use the corporate name and include your title, as shown below:

 

CORPORATION NAME

By: ___________________________________

Name and official title of the authorized signer

 

  • Maintain entirely separate bank accounts for your personal funds and your corporate funds, as well as separate taxes. Corporate tax liabilities should be paid from corporate accounts and personal taxes from personal accounts; the same is true for shareholders.

 

  • Assuming that you have corporate bylaws and other formalities, make sure that you follow all of them to a tee. This may include ensuring that meeting minutes are recorded, that the Board of Directors holds regular meetings, and that stock is issued.

 

See this related post from Dennis Harabin: Are Your Unemployment Benefits Taxable?
If you’ve collected unemployment compensation, the benefits’ impact on your tax bill will depend on a number of factors, including the amount of unemployment income you received, whether your benefits are covered by the $10,200 exclusion, what other income you have, whether you are single or married (and, if married, whether you and your spouse are both receiving unemployment benefits), and whether you had or have income tax withheld from benefit payments. 

The clearer and cleaner the line between the organization and the individual, the higher the level of personal protection, so make sure that there is a separation between corporate and individual transactions.

 

If you have questions about what type of entity is right for you we can help. Contact us today at 551-249-1040 for more information.

Does this sound too complicated? Dennis Harabin at Relax Tax makes it easy to understand.

 

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