Let’s Get That Business Organized INS Episode 03
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You want to start a business, you’ve got that idea firmed up, and now you just need to organize it. I’m not talking about cleaning up the clutter. This is the time where you need to decide on your business organizational structure.
Now I’m not claiming to be a CPA or an attorney, but what I can say is that I have first hand experience with two of the three options, although you’ll find out quickly what I think of the first one.
This list below is not comprehensive, but on this episode I do discuss some of the advantages and disadvantages of each.
Common Business Structures
The Sole Proprietorship
It’s been said that the sole proprietorship is probably the simplest way to operate a business. However, in my opinion, simple doesn’t always equate to better. If you are providing products and services and you haven’t yet formally picked a business structure, then you’re likely already operating as a sole proprietor.
I mention that it’s simple to set up, but again this doesn’t mean it’s the best option. Essentially there’s no separation between the sole proprietorship and the owner (you). This means that any income earned by the business is considered income earned by the owner. You can simply keep track of business income and expenses, and then report this on your personal tax return using the Schedule C.
The big issue here however, is that your business debts and professional liability doesn’t get to appreciate that “corporate veil.” If your business has issues with financial debts or is involved in a lawsuit, you will personally be responsible, and quite frankly I just don’t like the way this could play out for you.
The DBA (Doing Business As)
Now first I need to say that this is not an actual legal business structure, but rather a fictitious or trade name that’s used as a business name in lieu of your own name. This is typically the simplest and least expensive way for a small business to legally conduct business dealings under a different name.
The Corporation (C Corp)
A corporation is considered a separate entity in itself, and provides that “corporate veil” for the owner(s). Corporate debts and liabilities are not the responsibility of the owner and it protects the owner’s personal assets.
This is a formal structure that isn’t for everyone and does require a bit of extra work. This structure consists of shareholders, directors, officers and employees. A corporation must select at least one person to serve on its board of directors and the officers are required to manage the day-to-day. As an individual owner you can however have multiple roles in the company. The extra administrative headache comes from the corporation needing to vote on important company issues, and actually documenting all of this in the by-laws and meeting minutes.
As a C Corporation owner and shareholder, both a corporate and personal tax return are filed. The C corp pays taxes on the business profits and the shareholder must also pay taxes on the profits that is transferred to their personal return. This is actually a case where “double taxation” occurs, however there is a designation that can be established with the IRS, which leads us to an option that can help with this taxation issue.
S Corporation (S Corp)
An S Corporation is a sub chapter corporation that creates a “pass through” entity and reports profits and losses on the personal income tax return of the shareholders. The S Corporation owners are taxed on their percentage of shares of the company’s profits. The shareholder’s profits are not subject to any self-employment tax (Social Security and Medicare), which I’ll discuss in the next entity.
One of the important aspects to consider with an S Corporation is that if the owner is actually working in the business, then they must pay themselves a reasonable salary for these activities, which will in turn require the company to pay payroll taxes on those wages.
So to recap, you would organize your C Corp in the state you’re conducting business, and then you would elect an S Corp status with the IRS by filing form 2553. If you’re going to remain small, then you’ll likely not have to worry about the 100 shareholder or less requirement, however you and the other shareholders must be U.S. citizens or residents of the country.
The LLC (Limited Liability Company)
An LLC is what many consider a hybrid of a sole proprietorship and a corporation. The LLC does limit the personal liability of the owners, but it also doesn’t require the formal meetings and paperwork of the corporation. This does make it an ideal choice for a business owner that desires the liability protection, but doesn’t want the headache of handling meeting minutes and addendum paperwork that needs to be filed as a corporate entity.
The LLC by default is a “pass through” organization, although the owner does have some choice in how to be taxed. If the default designation is chosen, both the salaries and profits are subject to self-employment tax, which some consider another situation where “double taxation” occurs. The owner of the LLC can also elect the S Corporation status and appreciate some of the same tax benefits a C Corporation has (with the same S Corp status).
This in no way is comprehensive, however I do give a little more detail on some of the advantages and disadvantages that I’ve experienced in my own start ups. Remember, do your own research, and don’t hesitate meeting with an accountant about your own tax situation.
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[…] I recommend organizing your business entity as I mentioned in episode 3. You’re also going to need an Employer Identification Number (EIN), registering with your […]