There are many types of business entities and choosing the right one is critical.
Most won’t read this post all the way through before giving up. Many will scoff at it and say “That’s too much work”. So for those who read it, here is some legal gold on types of business entities and may you benefit by taking action and becoming a smart business owner with full legal protection.
One thing to take note of is that business entities and taxes are two totally separate strategies, so I will give an overview on both categories.
Types of Business Entities
DBA (Doing Business As)
A DBA(doing business as) name is not an entity and has no value other than for marketing and identification purposes. It can be filed for by any person (legally, LLCs and corporations are legal persons).
A legal entity has every right a human as but it cannot die and it cannot vote (with the exception of a sole member LLC, which will dissolve upon the sole owners death, THEREFORE MAKE SURE YOU HAVE IT IN YOUR WRITTEN WILL!!
A sole proprietor is you. Everything YOU or anyone working FOR you does is your sole responsibility. Advertising, marketing, branding, financing, risk, services, driving, walking, talking, liability etc. Insurance can be acquired to help cover SOME costs if something you be brought against you such as a property damage or personal injury lawsuit, but not everything. Most liability policies can cover copyright infringement and other random legal issues.
An LLC is a legal entity that has minimal structure and therefore is easy to set up and maintain with minimal effort. It is made up of one or more persons who are stated in the articles of formation or in an amendment, both which are filed with your state.
An LLC does not protect YOU personally, it only protects the activities of the business, its employees and it’s assets. Therefore, if you personally are doing the work, using your tools (owned legally by you personally and not the LLC) then you are just the same as a sole proprietor and have no legal protection under the LLC. However, if an employee of the LLC is performing work on behalf of (or advertising or financial etc ALL ON BEHALF OF THE LLC) the LLC and there is legal action, it will be against the LLC and not you personally. Therefore, if you own all of your assets legally and rent them to your LLC and become an employee of the LLC legally and are paid a W-2 wage, you are acting on behalf of the LLC. Any legal action would be brought against the LLC, but your assets could not be taken as they are owned by you personally and not the LLC. Ideally, you would set up a second LLC which would be the owner (a holding company) of your assets. This LLC would then rent or lease the assets to your operating LLC (the one that actually employs people and advertises) and then when legal action is brought against either LLC (operating LLC gets sued by a customer, holding LLC gets in financial trouble), the other is not affected (unless mentioned jointly in a lawsuit). Ideally, you would use several companies to protect you, your assets and your operations. This is the way of the wealthy. Once you understand it, it is quite simple and hard to penetrate legally.
You MUST take every deduction possible and there is some research that is needed to ensure you are getting the maximum deductions allowed. For example: if you buy older vehicles you should most likely be tracking mileage and using this deduction on your taxes, NOT depreciation. However, if you typically purchase new equipment or vehicles (or buildings) you should use depreciation as this will often give you the best tax benefits in reducing your income. There are traps in both however. You cannot take both and once you start with one you cannot switch to the other legally. Mileage covers depreciation, maintenance costs, fuel etc. Depreciation can be combined with actual fuel costs, maintenance and repairs (tires, oil changes etc). Only you can decide what is best for your business. Most rural operations benefit from mileage because they drive so much.
As a sole proprietor you have no choice but to file as an individual, however you do have the option to itemize you deductions (which YOU SHOULD BE DOING) or not to itemize. Using deductions itemized will in almost all cases reduce your “net” income as viewed by the government and therefore reduce the amount of tax you owe. Remember as a sole prop you don’t just pay income tax, you also pay a penalty tax. That’s right A PENALTY TAX! Self employment tax is very high and is paid on the full net income of the business after government deductions are taken.
As an single member LLC you have a choice to file your taxes as either as a sole proprietor or as a corporation (NOTE: There are two types and S-Corp and a C-Corp. Both have different tax laws, formation needs and other strict rules. S-Corp is the easier of the two and fits most smaller businesses better than a C-Corp). The confusing part here is that you do NOT have to be a corporation to file taxes AS a corporation. However you need to understand the pros and cons of both as making a mistake here can be very expensive.
Filing as a Sole Proprietor
This is the easiest way to file and is done the exact same way as a sole prop. All income earned by the LLC is claimed on your 1040 as YOUR income. Note: This does not mean you are a sole proprietor! This means you are filing your income taxes under the tax code of a Sole Proprietor, so you an operate an LLC and file your taxes as a Sole Proprietor. If you are an employee of the Sole Proprietor, you will then file the tax return claiming both your personal wages AND the income of your LLC as your income.
Filing as a Corporation
This gets complicated quick. First you need to understand that to file as a corporation (even when you are operating as an LLC) you MUST become an employee of the LLC and you MUST pay yourself a “reasonable” wage. Therefore you will become subject to income tax and W-2 withdrawals. You will also have to pay tax on your wages as an employer. Therefore for the W-2 wages you earn you will be paying taxes both on our paycheck and on the employer side just as you would any other employee. THIS IS CRITICAL! However there are some laws which in some states allow a corporation to avoid paying the unemployment tax that is imposed on individuals and soleprops. This is a small savings and is NOT legal in all states. Ask your CPA about this for your state.
Educating Yourself and Learning More
One of the best books I’ve EVER read about this is the Rich Dad, Poor Dad: What the Rich Teach Their Kids About Money–That the Poor and the Middle Class Do Not! (Miniature Edition)
(this is NOT the original Rich Dad Poor Dad book). This is the sequel and is the practical manual for how to build companies no matter what business you are in.
Here is a list of the Rich Dad Books. I recommend reading Rich Dad Poor Dad: What The Rich Teach Their Kids About Money That the Poor and Middle Class Do Not! book first, then follow up with Rich Dad’s Guide to Investing: What the Rich Invest in, That the Poor and the Middle Class Do Not!. This will be the best $20 you have ever spent.
Have questions or ideas? Share them below!
Legal: This post is not legal advice. You should consult with your attorney and CPA before making any legal or tax decisions.
Save a copy of this information and take it with you when you talk with your accountant and bookkeeper. Self educate! Don’t just trust that your bookkeeper or tax accountant knows best.Download
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