You’ve got it, a business idea with innovation and creativity, one that taps directly into the needs of consumers. A business idea so good, you told everyone from your mother to your mailman, your old mentor, and your priest. Maybe it has already developed and has clients, or you could be trying to start on the right foot. In either case, the most important thing you can do for you and your partners is structure wisely with the future in mind. Sometimes this can be a tedious, time-intensive process spanning days to months, filing (in-triplicate) dense bureaucratic packets divided into lettered sections numbered 1-5. But stay focused because the decisions you make towards this will affect every tax, regulation, litigation, and certification that applies to your business for years to come. From 501(c) non-profits to large class C-corporations, this guide has all you need to know to start your path.
Sole Proprietorship
For most new ventures, this is the optimum startup filing. You can take advantage of a sole proprietorship to keep things simple and elegant if:
Your company payroll is limited to a few people, and its income and assets stay in a favorable tax bracket. The benefit of a sole proprietorship is that regulators treat you and your company as one (even enabling you to use either your personal SSN or registered EIN). This freedom simplifies taxes and only requires a DBA registered with your state and appropriate licensing.
Pros
+Quick and easy to start and easy to manage
+Fewer regulatory requirements for day to day activities
+Tax benefits if your income stays below a specific threshold
+All profits go on your personal 1040 income tax return
Cons
–You are personally financially liable for your companies debts and taxes
–Can stunt or cap your growth rate
–If you do choose to incorporate, you must register a new EIN
Partnerships
Same as a Sole Proprietorship but must file a partnership tax return 1065 also must have an EIN
Limited Liability Company (LLC)
An LLC gives the most management flexibility while shielding you and your partners from liability. Unlike non-profits or corporations, a board of directors is not a requirement. You can choose to file as a pass-through, meaning the IRS will only tax profits on personal returns, or you can file as a corporation and be taxed twice.
Pros
+Personal liability protection
+More options when filing taxes forms 1065 1120 1120s
+Can be a sole venture (disregarded LLC) or a partnership
+Fewer requirements for annual filings
+Unlimited owners or members
Cons
–Are not recognized globally
–Cannot go public (IPO)
–Other countries may tax you as a corporation
Class C corporation (C-Corp)
This structure is the most preferred by investors and venture capitalists. In simple terms, there is no limit to its growth potential. You can issue unlimited stock to unlimited shareholders and do business in virtually any country that trades with the United States. C-corps are subject to double taxation by the IRS, once at the entity level and once at the shareholder level. The business pays corporate income taxes on its profits; thus, when the shareholder pays their layer of taxation, they do so on capital gains distributed from after-tax profits.
Pros
+Can trade stock publicly
+Unlimited shareholders
+Can distribute multiple classes of stock
+No personal liability
Cons
–Must have a board of directors and must file minutes
–Tax benefits decrease with lower annual revenues
–More red tape can make this structure unfeasible for smaller corporations
Class S Corporation (S-Corp)
More rigid than an LLC and fewer restrictions than a C-corp, Class S corporations meet somewhere in the middle. Like an LLC, profits and losses pass through the corporate entity and are filed on shareholders’ returns. Like a C corp, S corps can distribute common stock of one class. S corp shareholders are individually liable for taxes on their share of profits and the corporation filing corporate taxes. And shareholder-employees have their salaries limited by IRS regulation.
Pros
+Flexibility
+Profit is pass through to the shareholders
+No personal liability
Cons
–Have less the 100 shareholders
–Salary limitations for shareholder-employees
–Annual filing requirements
Exempt non-profits (501 status)
If you are driven to improve your community and have no desire for returns, then a 501 status will give you the freedom to raise tax-free public funds. This does come with many caveats. Most critical is that your company can never have owners, so no dividends or profits (ever). Your 501 is required to be managed by a board of directors who meet periodically and file their minutes. And point you must, because you must be wholly transparent with the IRS to maintain this status.
Pros
+Fundraising opportunities
+Tax exempt status
+Appears trustworthy and official to potential donors
Cons
–No profitability
–Regulatory red tape at every step
Final thoughts
Okay, take a breath. You know now the best entity type for your specific situation. By now, you should have some clarity for your next steps, but there is no shame in having questions. Thankfully, Just Jump agents are waiting by the phone to answer your questions and give you directions.