Resources
l

Nuts and Bolts: Nitty-Gritty Details, Incorporating, and Taxes

Nitty-Gritty Details, Incorporating, and Taxes

Now that we’ve gone through the building blocks of how to build a great company, it’s time to get down to the nuts and bolts. Sure, this stuff isn’t as glamorous as a lot of the other parts of starting a business, but it’s arguably the most important part!

Feeling lost? State governments have very thorough resources for helping you with the practical details of business. They may not help you generate great company culture or offer assistance in building your product, but they will help you understand tax requirements, laws, regulations, and other fundamentals introduced here.

Here are just a few examples of informative state government websites to check out:

Sole Proprietorship, Limited Liability, or Corporation?

Ok, so you’ve done some research, picked a great name, web domain and phone number to back it up, but now it’s time to get legally recognized as a business.

Sole proprietorship, limited liability (LLC), or corporation? These are all ways that the government can understand what sort of business you are so they can tax you accordingly.

These categories weren’t that meaningful before you wanted to start your own business, but now you’re scratching your head thinking about what they mean!

Pros and Cons of Sole Proprietorships

If you’ve decided to take on this endeavor by yourself, a sole proprietorship is probably the way to go. The advantage? Complete control.

Unlike an LLC, there aren’t any complicated legal agreements involved that determine ownership. If you’re a sole proprietor, you can run the business however you want.

The Pros The Cons

Complete control and flexibility to run the business as you see fit

Personally liable for all business debts, you’re all by yourself

Unlimited liability means creditors are more likely to extend credit if needed

Banks are reluctant to give loans due to higher turnover rates and usually smaller assets

You receive all business profits

Creditors can go after your personal property to satisfy a claim if your business assets aren’t enough

Smaller amounts of capital make for easier organization

Since the business relies on one person only, it is harder to raise capital on a long-term basis

Pros and Cons of Limited Liability Corporations (LLC)

If a corporation and a sole proprietorship (or a partnership) had a baby, it would be an LLC. With the limited liability characteristics of a corporation and the convenience of a flow-through income taxation (where the income of the business is filed as part of the owner’s personal income and not taxed separately), this option is suitable for multiple ownership circumstances.

The Pros The Cons

You have the flexibility of being taxed as a sole proprietor, partnership, S corporation or C corporation.

As an LLC member, you cannot pay yourself wages.

Less paperwork and lower filing costs

High renewal fees or publication requirements can be pricey, depending on your state.

You can form an LLC with as little as one person, but you can also have an unlimited number of members.

Many states have a franchise or capital values tax on LLC’s, ranging from a flat fee to an amount based on the company’s revenue

Flow-through income taxation, keeping things simple

Investors may be more likely to put their money into a corporation, making it harder to raise financial capital

Members are protected from some (or sometimes all) liability if the company runs into legal issues or debts.

Unless you are running the LLC alone, the ownership of the business is spread across its members (this can also be a pro)

Members can receive revenues (and write off forfeitures) that are larger than their individual ownership percentage.

 

Pros and Cons of Corporations

A corporation is a business entity that is legally separate from its owners. It has the right to enter into contracts, take legal action against others, give and receive loans, own assets, hire workers and pay taxes.

One of the most significant things about a corporation is its limited liability. That is, shareholders have the right to participate in the profits through stocks and paid dividends, but are not held personally accountable for the company's debts or legal issues that may arise.

Remember that famous trial where the woman successfully sued McDonald’s for serving their coffee at too high a temperature? Good thing McDonald’s was incorporated!

The Pros The Cons

Owners are separate from legal liability so they’re not entirely responsible when faced with legal issues or debt.

The process is time consuming and expensive, lots of paperwork.

Ability to sell stock, which raises the likelihood of acquiring financial capital.

Tons of regulations, which make for very little flexibility.

Well established structure with clearly defined roles, accountabilities and agendas.

Possibility of double taxation (where both the corporation’s profits and stockholder’s paid dividends are taxed).

Employees have the option to buy stock at a fixed-in price, and receive stock benefits.

 

What About Partnerships?

In this context, a partnership is a business union in which two or more individuals manage and maintain their business. Unlike a corporation or LLC, a partnership requires no incorporation paperwork with the Federal government. Therefore, the three types of partnerships – general, limited or limited liability – are somewhat informal structures.

In a General Partnership, all owners (or general partners (GPs) are equally responsible for the debts of the business, each assuming unlimited liability.

The Pros The Cons

Flow-through income taxation for all partners

Each owner is equally responsible for debt and loss

Less expensive and less paperwork than incorporating or filing to become an LLC

Creditors can go after your personal property to satisfy a claim if your business assets aren’t enough

Partners can pool resources and share the financial obligation rather than facing it alone

Liable for debts and actions of your partner

No rigid, obligatory corporate structure

Limited capacity to raise money and attract investors

In a Limited Partnership, owners can take on the role of a limited partner (LP) who reports to a GP (there can be more than one) and therefore have less responsibility in the event of company debt or accountability. The GPs have managing power, but also take on all of the liability for partnership duties.

The Pros The Cons

LPs have no liability and still make a profit

LPs have no managerial power

GPs have total managerial power

GPs have total liability

Flow-through income taxation for all partners

More filing formalities than a general partnership

Less expensive than incorporating or filing to become an LLC

LPs can lose all of their limited liability if they take on any management roles

Safer and thus more attractive to some investors

 

A Limited Liability Partnership is for those who want to assume as little responsibility as possible across the entire partnership.

The Pros The Cons

Flow-through income taxation for all partners

Available only for specific occupations

Has the flexibility to choose what kind of management structure it wants because everyone can participate in management roles

Partners are personally responsible for their own or any of their employees’ negligence regarding creditors, proprietors, etc.

Less expensive and less paperwork than incorporating or filing to become an LLC

 

Choosing a State to Incorporate (It Matters Where You’re From)

Since taxes, prices and corporate laws are not the same in every state, it is important to consider your home state’s advantages and disadvantages when it comes to forming your business.

Some things to consider when you’re shopping for states:

If you’re on the fence, check out our blog post about the seven best states to incorporate.

Get Yourself a Tax ID and Understand Tax Implications

Once you’ve decided what kind of business entity you are going to be and where you want to incorporate, it’s time to get a tax ID number (also known as an Employer Identification Number, or EIN). This means the IRS will recognize you as a business and allow you to pay your state, federal and local taxes. Yay!

This service is free, so if you are being charged for applying, beware!

The best way to apply for a tax ID number is online through the IRS website. You’ll be asked a series of questions, and upon validation you’ll receive your official EIN.

But what forms do I fill out?

The tax forms you file will depend on the type of business entity you have chosen.

Overwhelmed by the paperwork?

There are many helpful online services that will aid you in the process of forming your business. Not only do they do most of the work for you, they provide step-by-step instructions, filing expertise, customer service and personalized legal protection. On top of everything else, they save time and almost always save you money!

Here are some of our favorites:

We also recommend hiring a business lawyer or accountant for help with your taxes. A professional can better help you assess your options and protect your business than anyone else.

Resources We Find Helpful: