Guest post by: Andrea Sager
Being a small business owner requires hard work, knowing your marketplace, and managing both staff and customers. Many entrepreneurs start their passion project – be it a bakery, coding business, boutique or other business – without worrying about their legal status. While starting a new small business is exciting, diving headfirst into uncertain legal waters can land anyone in trouble. Without the proper legal structure, you may be exposing yourself and your small business to legal liability. The differences of the most common business entities among small businesses are discussed below.
*This is not legal advice, and you should consult with an attorney to determine your specific needs.*
Sole proprietorships are created once you start doing business. No forms, no formation paperwork, it’s easy and quick. The owner, or proprietor, is responsible for every action the business takes and business income is taxed as the proprietor’s personal income. This is advantageous to the extent that it is easy to form, you are generally aware of the rate you will be taxed at, and the only paperwork you will likely have to do is apply for federal, state, or local licenses to operate your business. However, those who consider sole proprietorships should beware because a lack of separation between you and your business means you will be personally liable for any debt or obligation the business incurs including judgments following a lawsuit. Additionally, your business can also be on the hook for personal debts of yours.
Doing Business As (or “DBA”)
Doing Business As, known as a DBA, is an entity which has filed paperwork to establish the proprietor is doing business under a fictitious name. For example, if you own and operate a dry cleaning business, you may opt for a DBA to change the name of your business to Best Dry Cleaners In Town instead of John Smith Cleaners. A DBA can be filed under any type of entity. If you have a corporation or an LLC, it can be named ABC LLC/Corp., but you can file a DBA underneath it in order to do business under a different name. Most states allow up to 10 DBAs under a certain entity.
When many think of corporations, they think of giant behemoths with several divisions, presidents, vice presidents, hundreds of employees, and expense accounts which have become the accoutrements of the corporate environment. What some entrepreneurs do not realize is that even their small business can become a corporation with the right paperwork. Contrary to the belief of some, there is no revenue or size requirement to become a corporation. While some businesses may “scale up,” meaning grow into, becoming a corporation, there are many others that begin their time in business as a corporation.
The requirements for creating a corporation as a small business are straightforward. First, you must file articles of incorporation in your state. This is usually a pro-forma document which can be found with the aid of a quick internet search or, preferably, a document drafted by a skilled attorney to ensure your wishes as a corporate founder are reflected and conform with any and all legal requirements. This will allow the corporation to exist as a separate legal entity with its own assets and liabilities.
Some corporations choose to incorporate in states that have friendlier laws and then do business in another. While this is perfectly legal, you will have to file a document known as a qualification or a foreign entity in the states you wish to do business in and pay any related fees. Unlike a sole proprietorship, you will have to pay corporate taxes on any business income and then pay personal taxes on any salary you pay yourself which some argue is double taxation for a corporate owner/operator. Finally, you will need to issue shares of stock and elect a board of directors even if there is only one shareholder. For example, if you are the only shareholder, you may elect yourself to the board of directors.
There is much more maintenance than other entities, and there are certainly more fees involved with a corporation.
Limited Liability Company (LLC)
Limited Liability Companies, or LLCs, are often the least understood legal framework for a business. A combination of a corporation and a sole proprietorship, LLCs combine the best of both types of entities. In some states, professionals like attorneys or licensed medical professionals who form an LLC may need to form a Professional Limited Liability Company (PLLC) to comply with state regulations. There is no meaningful legal difference between an LLC or PLLC.
Like a corporation, an LLC exists separate and apart from the people who make up the business. This means that you will still have to file paperwork to create the LLC and pay any fees. However, unlike a corporation, there is no requirement to issue stock, name a board of directors, and, most importantly, pay corporate taxes.
In an LLC, financial gain and losses stemming from the business are paid for solely through personal income taxes. This is referred to as “pass through” taxation as there are no taxes taken out at the business level. Although some LLCs elect to be taxed as an S-Corporation, many small business LLCs do not. Essentially, unless you elect to be taxed as an S-Corporation, you are still taxed the same as a sole proprietor.
What’s right for me?
As a small business owner, your two crucial commodities are time and money. While a sole proprietorship is convenient, there is the risk of unlimited personal liability for any issue arising out of the business, which creates harm for another. Any settlement levied against the business can also be levied against you personally. On the other hand, while a corporation protects you from unlimited liability, you will be facing more taxation, mountains of paperwork, deadlines, rules, and regulations that you may need to engage an attorney to keep up with. Neither one of these two scenarios are appealing for the cash and time-strapped.
For most small business owners, an LLC is the way to go. The time it takes to create and file an LLC is relatively quick and simple. Additionally, an LLC does not require a separate taxation scheme nor does it require as much continued maintenance like a corporation does. It also protects you from unlimited personal liability, a key element.
If you’re a small business owner and need assistance with establishing or protecting your business, contact attorney Andrea Sager at email@example.com to ensure your business has the framework it needs to succeed.