Business Structures (continued)
Becoming a corporation may seem a bit hoity-toity for a creative. It conjures up visions of monolithic, heartless companies that prey on small businesses. But this isn’t the case. Even the smallest of businesses can be a corporation, though it does require more thought and can be more expansive to set up than a sole proprietorship or partnership.
That said, a corporate business structure does offer you more protections, in part because a corporation is considered an independent entity, separate from its owners. As such, any debt belongs to the corporation, not the owner, so your personal assets aren’t on the line if things go wrong. Profits can also be retained by the business and not directly reported onto your personal taxes. You can even issue stock, though there are limitations based on the type of corporation you are – a C or an S.
The downside of a corporate structure is increased paperwork and regulation. Before you incorporate, you’ll want to discuss all the ins and outs with a tax expert, accountant or attorney. In Washington, you incorporate through the Secretary of State’s office. You will need to file the required articles of incorporation and bylaws that outline specific activities, such as when your annual meeting will occur, how officers are elected, their terms, etc.
An S-Corp is a good choice for many small businesses. It offers the additional tax benefits and liability protections a larger C-Corp enjoys. Income and losses are passed through to the shareholders (including you) and reported on individual tax returns. Personal assets are protected as an S-Corp as it is considered an individual entity that is separate from its owner. Instead of taking draws from the business as you would with a sole proprietorship, the corporation pays you via a paycheck. You are, in essence, an employee of your business, even though you are its owner as well. This differentiation is important if you plan to secure financing for a new home or car. A lender is much more likely to look favorably on an application if you receive a regular paycheck instead of paying yourself a draw from the business.
I learned this the hard way. I tried to buy a home at least three times when I owned my business, and it was a sole proprietorship. It wasn’t until I incorporated as an S-Corp that my loan sailed through the underwriters and application process. My credit hadn’t changed, my business wasn’t making more money than it had been, and my salary was still the same. I had become less risky to the lender primarily because I was getting a paycheck instead of drawing money from the same bank account. It doesn’t make sense, I know, but it is the way the financing and lending world works.
Because they have to follow the same rules as larger C Corporations, there are more filing requirements, including holding an annual meeting, maintaining minutes and voting on major corporate decisions.
Introduction: Are You Ready?
1. Thinking Like a Business
2. Business Structures
3. Access to Capital
4. Creating Revenue Streams
6. Finding Customers
8. Creating a Winning Pitch
9. Effective Negotiation
10. Intellectual Property
11. Managing Your Money
12. Going Global
What about a C Corporation?
The most significant difference between an S and C corporation is the way taxes are reported and paid. C corporations pay tax on their income, plus the income you receive as an owner, including any after-tax profits distributed as dividends. An S-Corporation doesn’t pay the tax on corporate profits, but passes them straight through to the owner’s personal tax filings. As such, an S-Corp eliminates the “double tax” you would pay with a C-Corp.
Limited Liability Corporation (LLC)
This is another favorite for creatives. It takes the best features of partnerships and corporations and mashes them together. Like an S-Corp, earnings and losses are passed through to the owners via their personal tax returns. Every member or owner of the LLC can participate in the company’s operations. LLCs can have an unlimited number of shareholders; an S-Corp can’t have more than 75.
LLCs offer owners limited liability, including protecting personal assets. Tax preparation is more straightforward than an S-Corp. Profits and losses are reported on the personal returns of the individual owners, much like a partnership. Profits and losses can be distributed between the partners according to the percentages outlined in the partnership agreement.
Stock is not an option in an LLC, so raising money from investors can be more complicated than with an S-Corp, and an LLC can’t offer stock options to a new hire in place of salary. With this business structure, you’ll need to file an operating agreement that outlines the rights and responsibilities of each member. This is similar to what you need to do in a partnership. Members of the LLC may have to pay self-employment taxes and Medicare and Social Security taxes.
Following is a quick cheat sheet to guide you through the various pluses and minuses of each structure:
|File With Secretary of State||No||No||Yes||Yes|
|Liability||Unlimited liability for debts and taxes.||Unlimited liability for debt and taxes.||Members are not typically liable for debts other than taxes.||Board of directors, annual meetings, annual reporting required.|
|Operational||Relatively few.||Relatively few.||Some formal requirements such as operating agreements and annual reporting.||Board of directors, annual meetings, annual reporting required.|
|Management||Sole proprietor has full control of management and operations.||Typically each partner has an equal voice, unless otherwise arranged.||Members have an operating agreement that outlines management structure/ responsibilities.||Managed by the directors who are elected by the shareholders.|
|Federal Taxation||Not a tax entity. Sole proprietor reports and pays all taxes.||Not a taxable entity. Each partner pays on their share of income and can deduct losses against sources of income.||Depending on the structure there is no tax at the entity level.||Taxed at entity level. Any dividends are taxed at the individual level.|
|Washington Taxation||Taxes based on business entity gross income.||Taxes based on entity income. General partners have limited liability.||Taxes based on business entity income. Responsible parties may have liability for trust funds.||Taxes based on business entity income. Responsible parties may have liability for trust funds.|