Business Financial Foundations and Fundamentals

I have learned quite a bit when it comes to starting and running a business. One of the things that oftentimes gets overlooked or at least severely delayed is the setup of a basic business structure. There are several different types of business structures. When I started I only really knew two structures in depth, but not much beyond those two. What are the business structures that really fit for small businesses?

1. Sole Proprietor
2. LLC - Limited Liability Company
3. S-Corporation

I knew of sole proprietor and had personal experience with that structure. I also knew of LLC since it offered some liability protection should your business require it. What I did not know is that the tax benefits between these structures and an S-Corp are like night and day quite literally. I will give a brief rundown of the differences, and will provide links for more in-depth study.

First we have the sole proprietor. The first question that I asked was how is such a structure taxed. I got my answer and did not like it at all. The basic truth is that as a sole proprietor you must report all business income and losses on your personal tax return, as the business itself is not taxed separately. When it comes to how much you pay in taxes the basic gist is that you pay 15.3% in the form of a self employment tax, and you pay another 24% tax as an income tax. So, can you imagine paying up to 39.3% in taxes? That would make someone not wish to do business. The next question for me was, what protections are in place for a sole proprietor, or in other words if someone wished to file suit against the business, what is the bottom line with respect to me and my own personal holdings? The answer to that is basically as a sole proprietor you are personally liable for any suits that are filed against the business. So, if someone should file suit and win, any and all personal assets are available and can be seized as restitution. Another thing to note is the sole proprietor business structure is the default business structure that the government will lump a business into that has not filed to be any other business structure.

For the LLC, one is afforded personal asset protection, however the tax structure is basically the same as that of a sole proprietor, meaning that you are still liable for up to 39.3% in taxes. I did not like that idea much either.

After lots of research and gnashing of teeth, I chose to utilize the S-Corp structure. I chose this structure because of the protections, as well as the tax structure. Utilizing this business structure provides legal separation between me and the business. This is the fundamental reason behind liability protection. An S-Corp is an umbrella business, making it possible to operate an unlimited number of DBA's (Doing Business As) within the corporation. As an S-Corp "shareholder", you are essentially an employee of the corporation so that self employment tax that is common to both sole proprietor and LLC, goes away. There are something like 330 tax deductions that are available to S-Corps. Operating costs are 100% deductible, and can include things like rent/utilities, internet access, gas mileage, cell phone, meetings, marketing, training, further investment, vacations, leasing of vehicles and so on. An S-Corp is in essence a pass through entity allowing some of the deductions of an S-Corp to be applied to my individual taxes. The basic paradigm is:

"Anything I do in the pursuit of profit is a deduction."

Needless to say the benefits here are phenomenal.

Each state has their own filing fees, but the what remains the same are the required forms needed to establish an S-Corp.

1. Pre-Incorporation Agreement
2. Corporate Bylaws
3. Shareholders' Agreement
4. Notice of Shareholders' Meeting
5. Notice of Directors' Meeting
6. Shareholder Proxy
7. Minutes of Shareholders' Meeting
8. Minutes of Directors' Meeting
9. Consent of Shareholders
10. Consent of Directors

It is obvious if you are the sole entity within the corporation that several of these forms can be abbreviated or passed over. The required forms can be found in your state at the Secretary of State website.

With any business it is a necessity to keep good records of expenditures as well as income, for the simple fact that it makes tax time a lot easier if you can simply go to the file cabinet and pull income, expenditure, marketing, training, and other such records at will. I cannot stress enough how important it is to keep good records on a daily basis.

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References:
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Business Ownership Structures at Nolo.com
How Sole Proprietors are Taxed at Yahoo Small Business

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