hey it's patti scharf CPA and co-founder of catching clouds the leader in
e-commerce accounting and today we're going to talk about different business
entity types now before I get started I want to give you a disclaimer I am NOT
an attorney I don't even do taxes anymore but I do know a little bit about
this information so disclaimer so one of the questions I hear all the time is
which is better an LLC or an S corporation and this question actually
drives me crazy because it tells me that there's a fundamental misunderstanding
out there about how to think of business entity types they're actually two
different structures one is the legal structure and one is a tax structure and
the legal structure will cover things like a sole proprietor a partnership a
limited liability company and a corporation you'll notice that an S
corporation isn't even in that list that's because that's a tax designation
so let's get started and talk about the different entity types ok sole
proprietor the sole proprietor is one of the easiest ones to understand it's the
easiest one to set up because basically you're just like hey I am now a business
and poof you're a sole proprietor so you don't have to necessarily file anything
you don't have to really do anything to be a sole proprietor you have no
paperwork you don't have to register with the Secretary of State however if
you have let's say you are Joe and you're starting up Joe's fish shop and
you want to use the name Joe's fish shop you will go to your Secretary of State
and you will register a trade name for that but that doesn't create an actual
legal entity and there's no liability protection in being a sole proprietor
the default tax treatment for a sole proprietor is going to be filing your
business information on Schedule C on your form 1040 which is your personal
income tax return you're going to pay federal income tax you're going to pay
state income tax and you're also going to pay self-employment tax that is 15.3%
you get a you get to take half of that as a
deduction on your taxes but in any case it's kind of an expensive way to do
business and there's no liability protection so if you're in a line of
business it's low risk you might do it if you're really really small you might
do it if one of my kids was gonna have a little business doing tutoring or
something like that babysitting that they're just gonna get a little bit of
money for it they would be a sole proprietor but other than that a lot of
people stay away from that business type just because the lack of liability
protection and the the fact that there aren't a lot of tax breaks doing
okay the next entity type is partnerships and I'm gonna kind of gloss
over this just a little bit I'll give you kind of the basics but
since there are so many different types of partnerships there's not really one
size fits all that I can tell you about on this video without like making it
really long so so partnerships is basically it's kind of like a sole
proprietorship where you but you have more than one person so you have two
people who get together and say I will now be a partnership they do have some
paperwork that they can file a partnership agreement and things like
that and register with the state one of the kind of crummy things about
partnerships is it's really kind of hard to divvy up Authority and there I hear
just all these horror stories about people who go into partnership together
and then it's a nightmare untangling themselves from from the partnership so
I'd say be careful with the partnership it's it it can it's very flexible you
can do a lot of things with it but it can also be kind of a hassle getting out
of it they do have their own business return that they file it's form 1065 and
what that does is it kind of gathers all the information for the business and it
says here's your income here your expenses here's the net amount that you
made and then it Divis it up between all the different partners so each person
gets their share of the income that's reported on their personal tax return
those are reported on Schedule k1 they take that over to their personal tax
return put the information on there and they all
pay the the income at the tax on the income at their own personal income tax
rate based on whatever their finances look like so they also pay
self-employment tax on in generally speaking for this partnership income the
next entity type is limited liability company now you'll notice I didn't say
limited liability corporation that's just something that like raises the hair
on the back of my neck up because it's not a corporation that's a different
entity type it's a limited liability company and what this is is you can have
one person you can have many people they are called members those are the owners
of the limited liability company and a reason why a lot of people like LLC's is
because they're just so easy to set up like literally in Colorado you you go
online and you say this is the name of my company you attach your articles of
organization which is not a lot of information like name and address and
that sort of thing not like just not tons of information and you pay 50 bucks
and boom you're an LLC so it's really flexible you don't have to deal with
some of the things that corporations have to deal with which I'll talk about
in a minute it's there just aren't a lot of Hoops to jump over you will need an
operating agreement that kind of just lays out who's in charge of what
operationally how you're gonna run your business
and that sort of thing but you don't need lots of red tape and regulation
there's there's not a lot that you really have to worry about for that the
LLC does give you some liability protection I would say I would but
before I say that I would I want to say that you have to treat your business as
a business separate from your personal if your commingling all your funds then
you're probably not going to get that liability protection that you're looking
for so if you go to the trouble of setting up an LLC you make sure that
you're treating it as its own entity and not commingling funds and sharing bank
accounts and credit cards and making it really confusing
the default tax treatment for the LLC depends on how many people are members
of the LLC so if it's a single member LLC which not all states allow but like
in Colorado they do and if you have a single member LLC then the default
treatment is to be what's called a disregarded entity basically just like a
sole proprietorship where the the IRS and the government just kind of go what
I don't see you as a company and they they let you file your taxes on Schedule
C on your 1040 so it just kind of pretends that the company is not there
if you have two or more members of the LLC the default treatment is a
partnership return so again you file your partnership return the
information gets sent out to the different people as far as how much of
that income relates to you personally and you file that on your personal tax
return so it's called a flow-through entity okay okay the last entity type
I'm going to talk about is a corporation now you you'll notice I didn't say S
corporation or C corporation that's because those are tax distinctions
that's how they are taxed it doesn't have anything to do with the legal
formation of the corporation itself so a corporation is the most administrative
Liebherr Dhin some entity that there is it's got lots of red tape it's got lots
of different things you got to keep track of and you typically have well you
always have shareholders so those are the owners of the company whoever has
shares of stock in this corporation they are the shareholders of the company
you've got the board of directors who oversees everything and make sure that
everything is going according to plan and then you've got the officers who are
kind of more boots on the ground making sure that everything's getting done
operationally that needs to be taken care of there is also a lot of paperwork
that has to do with the corporation you have to have minutes you have to have
bylaws you have to have shareholders agreements if you've got more than one
shareholder you've got articles of incorporation so a limited liability
company would have articles of organization the
corporation would have Articles of Incorporation one of the good things
about a corporation is there's a lot of legal liability protection with the
corporation it's easy to transfer ownership because when you have shares
of stock you just sell the stock and then you buy the stock and it's just
easily transferable and that's one of the big reasons why a lot of people use
it and it's easy to raise capital kind of for that same reason because it's
really easy for people to invest in a corporation now I would be remiss if I
did not talk about the C corporation an S corporation so let's talk about the
tax designations you know differences between the two for a C corporation this
is one of the things that a lot of people complain about when they talk
about double taxation so if you're filing your tax returns as a C
corporation then you are filing form 1120 and what happens is they take the
income and then the deductible expenses you get your net income and then that
actually that net income with adjustments or whatever becomes your
taxable income that taxable income is taxed at the corporate rate so unlike
these other ones that I was talking about they get that all flow through to
the personal tax returns that doesn't happen here it actually gets the
corporation itself actually gets taxed but the owners of the corporation if you
are working for the company and you're getting a paycheck your your any of the
money that you're pulling out of the business as wages that gets taxed on
your personal tax return and any dividends that get distributed from the
company gets taxed at the dividends rate on your personal tax return so that's
why they call it double taxation because the corporation gets taxed and the
individual gets taxed okay so let's talk about S corporations S corporations
people talk about these all the time you see lots of people who are hey you need
to be an S corp let me tell you why it's because it's treated more like a
partnership in the sense that you're not getting double taxed the company the
company itself doesn't have to pay tax the money the income that flows through
goes to the the owner of the business and they
pay tax on that but they don't have to pay self-employment tax on that so if
you've got a hundred thousand dollars and you've got one company that's being
taxed as say a partnership and they're paying fifteen point three percent of
self-employment tax and you've got this other company that's paying zero in
self-employment tax yeah you you know the S corporation is way more
advantageous however the S corporation one of the
rules of being an S corporation is that you have to pay yourself a reasonable
salary for working in the business so if you make a hundred thousand and your
wages are a hundred thousand it actually ends up being a wash so it kind of
depends on where on your personal tax situation and this is why you need to go
see a tax professional so I hope this helped if you'd like this video please
like it share it comment if you haven't already please subscribe and I'll catch
you later