Starting a Business Series: Choosing an Entity Type

When you start a business you must decide what type of entity you will be at first. You have many options and they can be overwhelming. I am going to make it very simple for you.

Most business owners start with the question of whether they should be an LLC, or not. There is a legal side of that question and a tax side of that question. Forming an LLC first happens with your Secretary of State. In most states you can do this inexpensively online. You can also pay low fees to have this done for you. If you are not comfortable, or do not have experience doing this, you should hire an attorney and they will do it for you. Once the LLC is formed this gives you an entity and your attorney can help you understand the legal protection that may provide. Then you get to decide your tax entity type.

If you are going to have very low taxable income to begin with, and you are the sole owner, you are likely okay being a sole-proprietor. That means you will file your personal income tax return with a Schedule C to show your business income and expenses. Then you will owe income tax and self-employment tax on your net income. This is a low cost and low burden way of handling things to begin with. Usually this is going to make sense for you in terms of the tax implications so long as your taxable income is not much more (or less) than what you would pay someone for doing what you do on a daily basis. After your net income exceeds that amount you should consider being an S-Corporation or some other entity type for potential tax savings.

If you are a partner in the entity you should talk with an attorney and a CPA to determine the best type of entity for you. You most likely will be a Partnership filing an annual 1065 tax return that has the net income, and related activity, flow through to the personal tax return of each partner.

When you start a business, you should consider the entity type from the beginning from a legal and tax perspective. Be sure you are talking with an attorney and a CPA to ensure you make the right choices that prevent future risk and tax burden in the future.

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