Sole Proprietor? LLC? Corporation? Which entity is right for your business? Today, I want to talk to you about the three main types of business entities that you can choose when starting your online business.
This is a question that a lot of people send to me. They don't know what to do. And they're not sure what strategy they should use when in terms of protecting their business from a legal standpoint. A lot of people think that LLC is the way to go. Some people say S-corporation. Some people have no idea what the differences between those are. And so hopefully, today's video will help you with that.
So there are three main types of structures that you can use. Now, let me just tell you before we start is that there's a lot of other structures you can use, just because we're going to be talking about sole proprietors, LLCs, and C-corporations today.
There's other things. There's partnerships, there's general partnerships, there's limited liability partnerships, and there's nonprofits. Those are a whole mess of business structures that you can use. Most of them are not relevant to you at all. So, you can just ignore them. Don't worry about them. But here are the three main ones.
Let's start with the sole proprietorship. This is the default option. If you do nothing else, you're going to be a sole proprietor. And basically when you form your sole proprietor, there is no distinction between you and your business. If your business gets sued, you're going to get sued personally, because you are the business. When you file your taxes, you're going to put all your business income and expenses are going to go right on your 1040. And so, there really is no distinction. When you're doing a sole proprietor however, there's a couple of things you do need to do or that you may want to consider.
You may want to make sure that you've registered your name with your state or municipality, wherever you're located. You may also want to make sure that you have the proper licenses and permits to engage in your business in whatever state it is where you're located. Let me just say another thing here. Where you're located is very important. The state you're located in is most important here. We'll talk about that a little bit more here when we get to the LLC and the C-corporation. But for a sole proprietor, that's the main things. If somebody joins you in your business and you're working with a spouse or another person, there's a possibility you could also become a partnership by default. But for most people that are in online business as just them, they're going to be a sole proprietorship.
Advantages and Disadvantages of a Sole Proprietorship
And the benefits to a sole proprietorship, it's informal. You don't need to do anything. Other than your trade name and maybe some permits and licenses, you don't need to file anything with the state to let the state know that you're in business. So, it doesn't cost any money. You don't need any operating agreements or bylaws or anything like that. You run your business and you keep track of your income and expenses. And that's what you do. Drawbacks are you're going to need to pay self-employment taxes on your earnings when you file your tax return. And you could be exposed to liability. So if you give a product, that if you sell a product that causes somebody harm, whether it be a product or a service, whatever it is you're offering to the public, if you cause somebody harm, you are going to be personally liable.
If you have significant assets or house or things like that, then those types of things could be taken if you were to get sued and somebody were to get a judgment against you. So, that is a sole proprietorship. That is the default. That is what most people choose when they're just starting out. Because let's be honest, if you don't have any revenue, if you don't have any income, you don't have a whole lot of money to used to form a business entity. And frankly, you shouldn't be. You should be focusing all your efforts on building your business and not worrying about this at the very beginning. So, a sole proprietorship is good unless you're in some sort of business that is a high liability business. If you are selling something that could subject you to some sort of personal liability or injure the people that are using it, you may want to consider something different.
The second option I want to talk about is a C-corporation. A C-corporation is basically a corporation. That's what most of the businesses that we deal with on a daily basis are. If you go to a franchise, that if you go to Starbucks down the street to get your coffee or do your work in the morning, Starbucks is a corporation. Most of them are Delaware corporations, which is something that you may think, well, shouldn't I be a Delaware corporation? That means they were formed in Delaware. And the answer to that is no. I've talked about that before. You should probably when you're just starting out, form your business in the state where you're located.
Advantages and Disadvantages of a C-Corporation
That's going to be the safest bet. Because even if you go filing it somewhere else like Nevada or Wyoming or Alaska or who knows where, it doesn't matter because you still have to register as a foreign entity in your own state. And so a C-corporation, that's where you're going to file. Now, there are some benefits and drawbacks to C-corporations as well. A C-corporation is expensive to file. You need bylaws and you need articles of incorporation. Also, you need to make regular filings with the state. It can become cumbersome. You may need an attorney to help you with that. And so, these are all some of the drawbacks. The benefits to a C-corporation are that you do get limited liability. So if somebody were to sue your business, they're going to be suing the corporation and not you in particular. And so, there is a benefit to doing it that way.
The other main benefit to a C-corporation is with this recent tax law that was enacted, you get a 20% tax on all the income from the corporation. However, you're also going to have to pay taxes on any money you pull out of the corporation as well. So if you pull money out in form of salary or a dividend, you're going to be paying taxes on that, as well as the 20% income tax rate. So if you're keeping all the money in the business and you don't plan on taking it out, then a C-corporation might be a good option. Now, we're not going to talk about S-corporations. That is a tax election that you can make with either the C-corporation or the LLC that is not a separate corporate entity. So, you need to be clear on that.
Limited Liability Company
The last entity I want to talk to you about today is what's called an LLC or a limited liability company. I've talked about this a lot in some other videos. A limited liability company is kind of a hybrid between the sole proprietor and the corporation. It is a business entity that you can choose. It's regulated by state law, wherever you live. There's different formalities to form an LLC, depending on which state you live in. And some states make it really easy to form. Other states make it more difficult to form. Again, you're probably going to want to form that entity in the state where you live and where you do business. Just because if you live in New York, there's no reason to form one in Wyoming. If you live in North Carolina where we practice, there's no reason to form one in Florida. You form the entity in the business where you live, where you work, where you do your business. That's where you're going to form it.
Advantages and Disadvantages of an LLC
That's going to be the best choice in almost I would say 99% of cases. There are some exceptions, but that's typically what we're going to do. So, the main benefits to an LLC are it provides you with the limited liability protection. And the liability protection goes two ways. So if somebody sues your business because the business did something, then you're protected personally. Also, it protects you because if somebody were to sue you personally, because let's say you're driving down the street and you hit somebody and killed them, then they would be able to sue you personally and get it on your assets. But they're not going to be able to get at the assets of the LLC. So, there's protection both ways. This is different than if you have a C-corporation. Because in a C-corporation, you're going to own what's called shares of that corporation. When you go buy stocks on the stock market, you're buying shares. Same thing here, you own shares of your C-corporation.
If somebody were to sue you personally, they can attach your shares of your corporation, then they can get all the assets in the corporation. So, that is a drawback to a C-corporation. Versus an LLC, all they can get is a charging order. And the effect of that is going to be different based on the state where you live. So, that's another big benefit to an LLC. The drawbacks to an LLC are very similar to the corporate drawbacks are number one, you need to file articles of organization for an LLC. You're going to need to have an operating agreement. You're going to need to adhere to that operating agreement and you're going to have to make annual filings. The tax return, you can either do a tax return as a separate entity or you can do a tax return on your 1040 if you don't make an S election or some other type of election with your taxes on a federal level. Also all the income from the LLC is going to flow through to your personal tax return, which is a benefit.
However, with the new tax law, you are going to get a deduction. I believe it's 20% of the income from the LLC. You're going to be able to deduct on your tax return. So, there is a nice tax benefit to operating an LLC as well.
Those are the three main corporate entities that you're going to need to know about for your online business. So again, we're talking about sole proprietorships, LLCs, and corporations. For most people, we're going to recommend the LLC. It offers the most flexibility. There's a lot of other benefits we didn't talk about here today, because this is a broad overview, very simplistic video of these different entities. But LLC is probably going to be the best bet for most people.