How to Protect Your Financial Interests with the Right Business Entity
Could a corporate veil help you sleep better at night?
Even with the best of intentions, there’s a lot of opportunity for things to go wrong in your business and the bigger your business gets, the higher your risk level soars. So does the amount of taxes you’ll need to pay. To protect yourself from liability and from an unnecessarily high tax bill, it’s important to register your business as the right type of entity.
Choosing a business entity and properly registering your business is a key step to protecting your personal assets. While it may not seem like your personal money has anything to do with your business, it does if you don’t choose the right business entity. The business entity you choose will also have tax implications, so it’s really important to get this right.
Keep reading for a breakdown of the different types of business entities and how they can protect your financial interest.
Sole Proprietorship or DBA
A sole proprietorship actually isn’t a legal entity at all and it’s what your business is classified as by default if you don’t form a business entity. While plenty of people skate by with a sole proprietorship in the early days of business, sole proprietorships aren’t a great long term solution as they don't limit your liability at all. That means, your personal assets like your home could be up for grabs if someone sues your business.
You don’t have to take action to become a sole proprietorship and you don’t have to file any paperwork or pay fees, so it’s tempting to stick with this option, but it’s not the best route to take. If you have a name for your business that is separate from your own, you can file a DBA (doing business as), which is similar to a sole proprietorship but with a business name of your choosing. Again, no real protection level comes into play with a DBA.
When you’re a sole proprietorship, you’ll deal with pass-through taxation, which means that the business doesn’t pay income taxes, you as an individual do. You’ll report any business income on a Schedule C attached to your personal income and will pay taxes at your personal income tax rate.
For some extra safety measures, you can choose an LLC (limited liability company) as your business entity. If you aren’t ready for the work that comes with forming a corporation (more on that in a minute), an LLC is an easier option for getting some personal protection. You have to pay a fee to become an LLC, but will spend less than you would if you form a corporation. While an LLC doesn’t fully protect your personal assets, it does limit your personal liability. With an LLC, pass-through taxation is the default, but you can elect corporate tax status.
Corporations are a type of legal entity that is separate from any single person. Because of this, they come with a decent amount of paperwork and tax requirements. There are different types of corporations (like S Corps and C Corps) available to you and it’s worth researching each type carefully. Your personal interests are completely separate from a corporation.
When it comes to taxes, how they’ll work depends on if you register your corporation as an S Corps or C Corps. With an S Corps, the IRS will link your personal income tax return to the corporate return. This means any income or loss will flow to your personal income tax return. With a C Corps your net business income will be taxed at the corporate income tax rate for a C Corps in your state, not an individual tax rate.
Not sure which business entity is the right fit for you? We’re happy to chat over your options so you feel confident in your decision!