Except during bouts of insomnia, I’ve never given much thought to the issue of business structure.
Sure, I know in theory that a business can incorporate, and that incorporation provides the business with benefits such as tax flexibility, protecting the owners from personal liability, and raising money by selling stock.
Every time I’ve looked into whether I should incorporate my own business, however, it has never made sense.
It would require a stack of paperwork. I’d have to pay a registration fee and annual renewal fee to the state of Washington. It would make my taxes more complicated without saving me more than a few dollars, if that.
And because my business consists of one person writing columns, incorporating would be unlikely to provide me legal protection if I were to commit libel or otherwise get sued.
So I’ve stuck with the most common business type in the US: a sole proprietorship. According to the Census Bureau, about 71.5% of US businesses are sole props.
Tax-wise, being a sole prop is relatively simple.
You have to file quarterly estimated taxes with the IRS, and then file a Schedule C and Schedule SE with your 1040 in April, but TurboTax and other tax software makes it easy. The state business license cost me $15, and renewal is free.
Recently, however, one of my hobbies has turned into a business, and a sole proprietorship isn’t going to cut it. I’m going to have to learn about business structure, whether I like it or not.
Two heads are better than one, except for tax purposes
My friend Molly and I co-host a comedy podcast. I’m not going to mention the name because lord knows I’ve promoted my own stuff in this column enough lately.
We’ve been doing the podcast for over three years and, except for one advertisement from a local company in the early days, have never made any money at it.
But we’ve slowly built up a loyal audience of listeners around the world. (The fact that you can crack a joke in Seattle and make people laugh in Singapore is one of my favorite things about the modern world.)
A couple of months ago, perhaps inspired by that Amanda Palmer TED Talk, we realized, hey, we could ask our listeners for money.
For $5/month, we offered listeners a handwritten postcard and access to a growing library of premium content.
To our surprise, people actually signed up. Not a huge number, but enough that suddenly our dumb hobby was paying for itself.
Great for us, but we’d need to share the news of our minor success with our friends at the IRS, the Washington Department of Revenue, and the city of Seattle.
Easy, I said: I’ll just consider the podcast part of my sole proprietorship, pay Molly as a contractor, and issue her a 1099.
This is perfectly legal, but (a) it’s a pain to disentangle the podcast income and expenses from those of my writing business, and (b) it’s not especially fair, since the podcast isn’t really my business, it’s a joint effort.
Furthermore, if we wanted to hire a tax preparer to handle our business taxes (which we might want to do), it would be impossible to do so without also turning over responsibility for preparing my own tax return (which I don’t want to do).
So we need to look at a business structure that reflects Molly’s and my joint ownership of the enterprise (trust me, describing our show as an “enterprise” is droll) and separates the potentially hairy parts of the business taxes from my own taxes.
As the personal finance columnist in this business relationship, it falls to me to investigate the possibilities, and I’m looking at three.
A general partnership
A partnership is essentially the group version of a sole proprietorship. It requires no special paperwork to form one, just a business license.
Partnerships file a tax return with the IRS and pass all profit or loss on to the partners via the K-1 form. Partners are personally liable for all of the partnership’s debts.
A limited liability company (LLC)
An LLC, in most cases, works the same way as a partnership, but as the name implies, the legal liability of the owners is limited. If our company goes bankrupt, creditors can’t come after my personal funds unless I act negligently.
We don’t have any creditors at this point, but that could change when we decide to construct a theme park.
LLCs require more paperwork and fees than partnerships. In Washington State, the initial fee is about $200 and there’s an annual renewal fee of $69. The federal and state tax filing is similar to a partnership.
An S Corporation
The “S” actually stands for subchapter S of the Internal Revenue Code, but you can think of it as a “Small” corporation.
An S Corporation is limited to 100 or fewer stockholders and is restricted in other ways compared to (usually larger) C Corporations.
In exchange for meeting the restrictions, S Corporations can save their owners on taxes in various ways and are generally more flexible in structure than a partnership or LLC.
The fees for an S Corporation in Washington are the same as for an LLC, but the paperwork is much more heavy-duty.
You have to hold an annual board of directors meeting and take minutes (adult beverages may be served), and the corporation would have to file its own tax return and pay Molly and me as employees.
I’ve tentatively decided that an LLC makes the most sense.
It keeps the paperwork to a minimum while providing us some legal protection in the event that, well, I can’t actually think of how we could end up in debt since our business consists of sitting around and talking. But it couldn’t hurt.
Plus, we get to put “LLC” at the end of our business name, which sounds totally legit.
There are a lot of other nuances to the decision of when and how to incorporate. These are just the very basics.
(It’s possible, for example, to be an LLC but be taxed as an S Corporation and zzzz….)
For a more detailed but still gentle overview, I recommend Mike Piper’s book LLC vs. S-Corp vs. C-Corp Explained in 100 Pages or Less.
If you own a small business, how did you decide on a business structure, and have you been satisfied with the decision?
Matthew Amster-Burton is a personal finance columnist at Mint.com. His new book, Pretty Good Number One: An American Family Eats Tokyo, is available now. Find him on Twitter @Mint_Mamster.