Starting your small business is an exciting – although often overwhelming – time. You know what you want your business to do and you’re ready to jump in with both feet, but in order to establish a business that will last, you have several decisions to make as you create your business entity. BradyRenner’s CPAs have years of experience in guiding small businesses and are ready to help you begin your journey with business entity planning and selection in a way that will provide you with the tools for long-term success and growth.
How a CPA Guides Business Entity Planning
Your CPA is a vital component of your business entity planning and selection. Their first order of business will be to evaluate your idea for a business and help you determine its sustainability and profitability.
As you embark on converting your ideas into a business plan, a CPA has the financial know-how to guide your plan regarding tax efficiency as well as financial health. With your CPA’s help, you can make an informed decision about which type of business entity and what kind of tax method will best serve your business.
Two Types of Business Entities
Your choice of business entity is between a Limited Liability Company (LLC) and a corporation. The main difference between these two entities is that an LLC is owned by one or more individuals, whereas a corporation is owned by its shareholders. There are advantages and disadvantages to both business entity options, but BradyRenner recommends LLCs to most clients based on the current startup costs and tax implications.
An LLC is usually considered the easier of the two options to maintain, which makes it attractive to small business owners. LLCs offer protection for the owners’ personal assets, meaning that if your business is in financial trouble, you would not be required to offer your home as collateral. For issues of ownership, LLCs provide more flexibility. If an LLC wishes to grant equal ownership regardless of initial investment, that is their decision. And managing an LLC is entirely the purview of its members.
A corporation also offers limited liability protection for its owners, however there are far stricter rules for a corporation than for an LLC. For starters, a corporation is taxed as a separate entity. Once the corporation has paid taxes on its dividends and profits, then those dividends are not tax deductible, meaning they are subject to double taxation.
In a corporation structure, the more shares a shareholder owns, the more control she has of the corporation. And managing a corporation requires more rigorous oversight than an LLC: a corporation must have a board of directors and corporate officers in charge of making business decisions. These directors are elected by the shareholders.
Four Types of Tax Classification
The next decision you will need to make at the start of your business entity planning journey is the tax structure: S-corp, C-corp, sole proprietorship, or partnership. An LLC can choose any of these four structures, while a corporation is limited to either S-corp or C-corp. There are pros and cons to each option, and your CPA can help you determine which suits your small business best.
- Taxation as a C-corp is the default option for corporations. C-corps are not considered a pass-through entity which means they are double taxed: first on the corporate level and then at the personal one. While these are not generally advisable structures for a small business, there may be exceptions.
- S-corps are considered pass-through entities, so no double taxing. There are, however, strict parameters for this structure, including the restriction against more than 100 shareholders, and the requirement that those shareholders be U.S. citizens.
- Sole proprietorship is only an option for businesses with one owner. A sole proprietorship is considered a pass-through entity and is therefore not subject to separate taxation.
- Partnership is only available to businesses with more than one owner. Like sole proprietorship, partnership is a pass-through tax structure. This is why neither of these options are available to corporations.
Our Experience Informs Our Recommendations
BradyRenner’s extensive work with small businesses gives us unique insight into the business entity selection you should make. In today’s world, C-corps are publicly traded companies. In our experience, C-corps are typically not the best option for small businesses. Between the pricey startup costs as well as the issue of double taxation, there are very few instances where we might recommend establishing your business entity as a C-corp.
Instead, BradyRenner generally steers clients towards the LLC option because of the high level of flexibility. However, as a firm we work together with our clients to make decisions with all the specifics of their small business in mind, including company size and how quickly the small business is expected to grow.
BradyRenner’s team of financial experts is ready to help you begin your journey as a small business owner. Contact us today to learn more! And check back for the second installment in this blog series which will address the initial setup and management of essential accounting, bookkeeping, and financial reporting systems and processes.