Today, I will show you how to choose the right business structure type for you by answering the top 5 most common and important questions.
2. What are the main business structure types?Sole proprietorship is the default business type when you start a business as a single person.
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Many sole proprietors don’t even know they are sole proprietors. They call themselves, “freelancers, ” or, “self-employed.” But if they are not partnering with anyone and never set up a business entity, they are sole proprietors.
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You usually don't have to file with the government to be a sole proprietor. Legally, you and the business are the same entity under this business structure.
For example, if you and a buddy decide to sell lemonade on the sidewalk, the two of you together would be considered in a partnership.
Limited partnership is when one or more of the partners/owners in a company invests assets into the business but does not manage any business operations.
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This is similar to a partnership except that one or more person's sole role is to provide resources or capital for the company. The business person(s) providing capital is known as a
For example, if you provide you buddy $200 to open a lemonade stand, and your buddy runs the lemonade stand by themself, then you are a limited partner, and your buddy is a general partner.
Limited liability company (LLC) status provides legal protection with the state by making a company its own entity separate from its owners.
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For example, if you and/or a buddy open a lemonade stand and register it as an LLC, your taxes do not change. However, the state will recognize your company as having its own identity separate from you.
For example, if you and several others establish a chain of lemonade fast food locations, you may want to consider registering as a C corporation.
Means to set up a business so that it carries its own identity separate from the owners of the organization. It is a separate legal entity under state and federal law. Corporations pay their own taxes, can initiate litigation, and be sued independently from their shareholders.
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When you are either an LLC or a C corporation being taxed as an S corporation, then the company will still be treated as a separate entity from you, the company owner. Therefore, S corporation status to not affect your liability.
Either you or your business (generally not both) can be held liable for damages in a court of law depending on the business structure type you pick.
You can be sued by anyone for any reason. Not anyone can win a case against you or have a viable reason for suing you, but you or your business can be sued nonetheless.
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For example, let’s say you unintentionally use a product image that belongs to someone else. You downloaded the image from a “free stock photo” website, but the photographer sues you anyway because they never gave the website permission to distribute the photo. You could be held liable and have to pay compensation including legal fees.
In this case, anything you own is fair game. You could lose your house, your car, your 401K, your dog—anything you own is at risk.
In this case, what your business owns is at stake. You could lose your inventory, profits, and business assets, but what you personally own is not at risk.
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If neither of these two things are true for you, then your chances of someone suing you at this stage are almost zero.
If you are a C corp, S corp, LLC, or limited partner, you have liability protection. Legally, your business is treated as a separate entity from you. Therefore, your business is liable in case of a lawsuit, but no one can seize your personal belongings and assets.
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Unless you leverage debt and assets to lower your income to net zero, similar to what Robert Kiyosaki does, there are no legal loopholes to avoid paying taxes. Don't risk fines or jail time!
Compensation includes both wages and bonuses. Wages are regular paychecks based on hourly or salaried pay. Bonuses are one-time or periodic payouts based on work—not ownership in the company.
For example, if you make $5, 000 per week regardless of how many hours you work, that is a salaried wage. If you make $15 per hour you work, that is an hourly wage. Salaried wages and hourly wages are taxed the same way.
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If you receive $500 as a one time payout each Christmas from your employer, that is a bonus. If you work in sales and get $10 pay for every $100 of revenue you personally bring to the company, that is also a bonus because your payout is based on your work performance.
For example, if you make $5 for every $100 the company makes, that is a dividend. Dividends are also called distributions depending on the company type.
In other words, you must pay income tax on every dollar you make. Income tax is owed once a year to the US federal government. Some states, like California, also collect income tax. Some states, like Texas, do not collect income tax.
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This is why if you are an LLC, general partner, sole proprietorship, or are taxed as an S corporation, all your income is considered “pass-thru” income. With pass-thru income, there is no distinction between your company's profits and your income. The two equal one another.
The government collects 12.4% of your wages for Social Security tax. When you are employed, your employer pays half of the social security tax (6.2%). You will pay the other 6.2% when you are employed. If you are your own employer, you must pay the full 12.4% yourself.
However, there is a cap on how much Social Security tax you have to pay. In 2021, Social Security tax is charged up to a $142, 800 compensation cap. This cap fluctuates each year. The cap means if you make $150, 000 as an employee in 2021, you will only be taxed the 6.2% on $142, 800 of your wages.
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This tax funds the US Social Security program, which pays for the retirement, disability, and survivorship benefits received by millions of Americans each year.
The government collects 2.9% of your wages for Medicare tax. When you are employed, your employer pays half of the Medicare tax (1.45%). You will pay the other 1.45%. If you are your own employer, you must pay the full 2.9% yourself.
There is no cap on Medicare tax. For example, if you make $150, 000 as an employee in 2021, you will be taxed 1.45% on $150, 000 of your wages—even though the Social Security tax cap is $142, 800.
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If you are a partnership (more than one member), the profits are split among the members. Each member must pay income and FICA tax on their earnings.
For example, if your sole proprietorship net income is $100, 000, then you pay 24% of the $100, 000 for income tax ($24, 000) and 15.3% in FICA taxes ($15, 300), totalling to $39, 300 in taxes.*
If you are a shareholder of a C corporation (owner) and do tasks on behalf of the company (are your own employee), you pay:
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C corporations are the only company structure (of the six we have considered) that pay taxes as a company. They pay taxes on company profits.
Second, those same profits are taxed again at a personal income tax rate when they are distributed to officers, other employees, and shareholders as compensation or distributions.
If the shareholders are in the 25% income tax bracket, each pays $9.88 in personal income tax plus 15.3% FICA tax ($5.97 each).
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C Corporations may pay shareholders with dividends and/or compensation (wages and bonuses). C Corporations are not required to pay compensation to their shareholders. C corporations are required to pay compensation to their officers/employees. Both shareholders and officers pay income tax on the money they receive.
If the C corporation chooses to pay its shareholders dividends instead of salaries, then the shareholders do not pay FICA tax on those dividends. This benefits the shareholders.
If the C corporation chooses to pay its shareholders compensation instead of dividends, the shareholders have to pay the 15.3% FICA tax.
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You may be thinking: Can a C Corporation pay dividends instead of compensation to its officers running day-to-day operations (who happen to be shareholders)?
The IRS says, “When corporate officers perform a service for the corporation and receive or are entitled to payments, those payments are considered wages...The fact that an officer is also a shareholder does not change this requirement. Such payments to the corporate officer are treated as wages.”
If C corporations try to pay officer-shareholders exclusively dividends, the IRS is going to see that as compensation. Those officers running the company are required to pay FICA tax on their compensation.
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C corporations are not required to pay salaries like S corps are. However, if no one is hired, then the IRS can
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