Business owners have several choices of how they can operate a business. The decision should be well thought out and be able to meet their objectives. Here are some of the pros and cons of each structure:
Sole Proprietor: The easiest form of operating your business is as a sole proprietor. A sole proprietor has a much lighter administrative burden because you account for your business activity on your individual tax return. You may not need to file quarterly payroll tax returns, and may not need worker’s comp insurance. The downside to operating as a sole proprietor is unlimited legal liability, high self-employment taxes, and a much, much greater potential to be audited by the IRS than other taxpayers.
Limited Liability Company: A limited liability company, usually referred to as an LLC, offers greater legal protection than a sole proprietor, and is also extremely flexible. Depending upon various factors and elections, an LLC may be taxed as a sole proprietor, partnership, C-corporation, or S-corporation. In practice, we usually see single-member LLC’s that are taxed as sole proprietors, which means that they have the same downsides as well.
C-Corporation: A C-corporation offers legal protection like an LLC. The drawback is that you have to abide by more legal formalities, including paying yourself reasonable wages, hold annual meetings and take minutes, and also pay additional corporate taxes. When you want to distribute the corporate’s profits, you will pay taxes yet again as they are considered dividends. C-corporations have their place, but are generally suitable for larger corporations.
S-Corporation: A variation of the C-corporation is the S-corporation. An S-corporation operates just like a C-corporation, but avoids the corporate level tax by taxing profits on the owner’s individual tax return, and has the potential to save employment taxes. The downside to an S-corporation is a higher administrative burden.
As you can see there are many pros and cons to each business structure and the decision should not be taken lightly. If you are thinking about choosing or changing your business structure, then you need to speak to a CPA or attorney who is very experienced with these matters.