When starting a sign business of any type of business, your first decision will be what form of business to choose. There are four basic choices, a sole proprietor, a partnership, an LLC (limited liability company) or a Sub Chapter S Corporation. In this article we will cover the basics of all these business forms and list the pros and cons of each.
The first form of business that you can choose for you sign company is a sole proprietorship. Many businesses start out as sole proprietorships because it is so simple to form one. In most states and counties you only need a business license and a checking account. A proprietorship has one owner who makes all decisions and who is personally responsible for the liabilities of the business. For tax purposes you and the business are one in the same.
The advantages of a sole proprietorship are that it is easy to set up without the help of an attorney or accountant. You control everything and keep all profits and taxes are relatively simple. On April 15th you simply file a schedule C along with your personal return. Most tax programs include this at no additional charge. If you wish to close the company it is fairly easy and straight forward.
Sole proprietorships do have some disadvantages. All liability falls on the owner personally. If the business incurs a liability from a lawsuit the owner would be personally liable. Although a liability insurance policy can help cover this, it is something to consider. There are some tax disadvantages as far as social security is concerned but like all companies you are able to write off things against business income that you normally would not be able to write off. Lastly, a sole proprietor will generally be taken less seriously than an LLC or Corporation. Also, audits by the IRS may be a little more frequent for this form of business.
The second type of business form is a partnership. Partnerships are just like sole proprietorships but with more than one person. There is a need for a partnership agreement which may require an attorney. Profits are split as is the decision making process. Liability issues are the same and one partner can create liability for the other through negligence or bad decision making. The main disadvantage is the lack of control by any one partner which can lead to slow decision making or conflicts within the company. For tax purposes the profits of the business flow equally to your 1040. This form of business is simpler to form than a Sub S Corporation or LLC but the potential problems may offset the advantages.
I would recommend a partnership only in situations where each partner brings something to the business that the other cannot. If you can avoid having a partner then I would. If you are going into business with a spouse then that is fine. But you can do that using an LLC or Corporate structure as well.
The third type of business I want to cover is an LLC or Limited Liability Company. This is a relatively new form of business and is available in almost every state now. Once you form the LLC you can elect to be treated for tax purposes in several different ways. The LLC basically protects you from liability. The LLC is designed to provide the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership. Forming an LLC is more complicated than a general partnership or sole proprietorship but normally easier than a Sub S corporation.
The last form of business is called the Sub Chapter S Corporation. It is actually just a C Corporation that has filed for Sub S treatment by the IRS. This means that profit passes to your 1040 via a K1 and is not double taxed.
Many business owners prefer this form of ownership because of the limited liability it provides as well as the tax savings. The corporate protection means that the shareholder is not personally liable for what the corporation does. In the case of negligence, however, there would be no protection for the individual who was negligent. To further illustrate this liability shield assume an employee borrows a company car and injures someone while they are under the influence. The employee would be personally liable since they were negligent and were driving the vehicle. Secondly, the corporation would be liable since it is the owner of the car. Lastly, the shareholders of the company would not be liable personally so their personal assets would not be at risk. As far as taxation goes a shareholder can take a fair salary for what they do in the company and take the rest of earnings in the form of a draw. If the salary was fair and reasonable by IRS standards they can save social security on the draw portion. If it is not reasonable the IRS can require that the shareholder pay social security on all earnings and even go back to previous years. The general rule it to pay yourself a fair salary before you take draws. You would receive income into your 1040 via W4 earnings and a K1 at the end of the year which would cover the draws and any excess income.