Some people start their own businesses to have control of their own destiny. Others may feel they have little choice if they’ve been laid off. Others yet may simply feel they can make more money.
Whatever your reasons for starting a business, you have one thing in common with everyone who starts their own company: You must decide what type of business you are. Should you form a corporation, where you stick the “Inc.” after your company’s name? Should your business be a limited liability corporation, or LLC? Should you bypass those concerns and simply start selling your products and services, designating you a solo practitioner?
If you’re struggling to come up with a good answer, that’s because there is no right answer. That said, there may be better answers for you than others. Just because you can form a corporation doesn’t mean you should. Maybe a crash course in the lingo and a quick tutorial on what all of this means will help.
[See: A Guide to Launching Your Side Business.]
C Corporation. Unless you have incredibly deep pockets and are planning to hire a slew of employees off the bat, you’re probably not going to go this route. It’s a complicated way to start a business that requires shareholders, a lot of paperwork and an understanding of tax laws. Here’s a good rule of thumb: Most business experts recommend hiring an advisor or an attorney to help you set up a C Corp designation. Can’t afford to hire an advisor or attorney? Then you can’t afford to be a C Corp.
S Corp. If you’re an S Corp, you pay yourself a salary, and you’ll receive dividends from any additional profits the corporation might earn. If you’re thinking, “But I’m just starting this and barely know what I’m doing. I don’t know if I’ll have profits,” then your business should probably be the following designation or the one after that.
And, by the way, if you do form an S Corp, hiring a tax advisor or attorney is also a good idea.
[See: 9 Red Flags That Could Trigger a Tax Audit.]
LLC. If your business involves any genuine risk, where somebody could sue you for the way you’ve run your business, then consider getting your business designated as an LLC, says Eric Liguori, an assistant professor of entrepreneurship at the University of Tampa. If you have an LLC, a lawsuit might destroy your business, but you personally can’t be sued. That means you might lose your business but not your house.
Liguori says he understands why someone might see it as “overkill,” but “from day one of doing business, you are taking on the liability of that business. One case of food poisoning, one unintentionally mislabeled package or one bad piece of consulting advice offered could result in a lawsuit. The cost of filing an LLC in most states sits under $200, making an LLC too affordable to not take advantage of.”
And as with the S Corp and C Corp, hiring a professional to help you through this is a good idea, although there are online services designed to do this as well.
Solo practitioner. Many experts recommend beginning here. “Especially for new businesses, I think a lot of people jump into entity planning too fast, before determining if they have a workable business that will be successful,” says Crystal Stranger, president of 1sttax.com, an online tax preparation site for small businesses, and the author of “The Small Business Tax Guide.”
She further sings the praises of the sole proprietor or partnership by saying that it makes it easy to close the company if things don’t work out.
[See: Spend a Windfall Wisely.]
How to Decide
Much of it comes down to learning as much as you can about the various designations (and those were simply the four most common; if you’re going to start a nonprofit, that’s an entirely different kettle of fish). For instance, if your inclination is to create an LLC, and yet the business you’re starting isn’t all that dangerous to anyone (i.e., you’re starting a website selling office supplies or opening a small flower shop), you might be better off just buying business liability insurance, according to Abby Eisenkraft, CEO of Choice Tax Solutions, Inc., in New York City.
Because while an LLC filing may be cheap in a lot of states, that isn’t always the case.
“In New York, LLCs can be very expensive to set up, and the proper formation of an NYC LLC can be easily over $1,500,” Eisenkraft says.
Another important thing to remember? It’s very easy to start off as a sole proprietor and later become an LLC. Once you become an LLC, an S Corp or an Inc., it’s harder to change that designation without incurring a possible tax hit (due to re-filing and reclassifying your business with the IRS).
That’s why Kara Cohen is holding off on deciding what designation her company will be when it grows up. She owns Transmitter NYC, a new marketing consultancy for startups and smaller companies. Cohen, who started her business in June, sometimes hires contractors but otherwise, it’s a one-woman show, and she says she is remaining a solo practitioner for now.
“The reason being, I’m not exactly sure how my company will develop. I do different types of work for different clients and I want time to solidify my direction before I go towards an LLC [or anything else],” she says. “There’s no real reason to commit to something until I know exactly what I want to commit to.”
Still, a lot of your decision probably will come down to the costs of designating and how risky your business is. If you’re buying a food truck and you can imagine a lot of worst-case scenarios, like running over somebody’s car and having that disgruntled motorist seek revenge in court, common sense says to follow Liguori’s path. If you’re launching a money-making blog about the food truck industry, Cohen’s approach is probably the way to go.
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Starting Your Own Business: Should You Incorporate or Not? originally appeared on usnews.com
