Wanna Start A Business?
You might say a good idea officially turns into a real, live business the moment you sign a form creating a new legal structure. It can be an intimidating moment for new business owners. Even if you know everything there is to know about the work you’ll be doing every day in your new endeavor, some of the details of forming a company are probably outside your areas of expertise, unless you’re opening a combination law and accounting office.
That’s why it helps to know the different types of those legal structures when you want to launch your business.
But how do you begin?
Kickoff Questions
John Rainey, regional director of the Massachusetts Small Business Development Center at Clark University in Worcester, said one of the first questions he asks someone who’s starting a business is about worst-case scenarios.
“What’s the chance something bad could happen in your business?” he said. “In other words, we try to do a risk assessment of what could go wrong.”
Along with risk, a related question is how much a new businessperson has to lose. Any chance of being sued, no matter how small, will be a bigger deal to someone with a summer house and an antique car collection than to someone who has virtually no assets. In some cases, it’s also possible to eliminate risks with insurance.
If liability is really not a concern, a business may be able to get away with operating as a sole proprietorship. Curt Feldman, a partner at accounting firm Shepard & Goldstein’s Framingham office, said all that’s needed is registering the business with the city or town where it’s located.
“Literally, they just open up the business in their own name,” he said.
When it comes time to do the taxes, the profits or losses of a sole proprietorship flow right through to the owner’s personal income tax forms. The only thing that’s really different from income earned as an employee is a self-employment tax — essentially just the cost of Social Security taxes that would normally be paid by both the employer and the employee.
Starting Out As Sole Proprietor
Jeffrey Donaldson, an attorney with Mirick O’Connell in Worcester, said he sometimes advises clients to operate as sole proprietors during the very early stages of forming a business, when they’re planning and doing research, rather than actively selling their services. Once a business is really in motion, he said, it’s “hard to imagine” very many companies that could safely operate as sole proprietorships.
“There’s risk everywhere,” he said.
For anyone wanting a more formal structure, there are three basic choices — a “C corporation,” an “S corporation” or a limited liability company, or LLC. All three offer liability protection, insulating owners’ personal property from lawsuits against the business, but there are some significant differences.
C Corp = Corporation
A “C corp.” is what people usually mean when they say “corporation.” The structure is right for big publicly and privately traded companies, and for some companies that intend to get big, Feldman said. It allows for complicated ownership, with things like common and preferred stock, or profit sharing for employees. But it also comes with lots of chances to pay taxes. C corps. are taxable entities, so they pay taxes on their own profits. Then, they often pay a dividend to stockholders, who have to pay taxes on it as well.
S corps. have some extra restrictions that C corps. don’t. They’re limited to 100 stockholders who must be U.S. citizens or resident aliens, and they can only have one class of stock. But they also have a distinct advantage. For tax purposes, their profits flow right through to the owners’ pockets without an extra layer of taxes.
Donaldson said S corps. were quite popular in the past, but in recent years more business owners have opted to form LLCs instead. That’s partly because they involve less paperwork. Both corporations and LLCs must be registered with the Massachusetts Secretary of the Commonwealth’s office, but the corporate form demands additional work like holding annual meetings, issuing stock and writing bylaws — even if there’s only one stockholder.
“LLCs don’t have the annual compliance things that corporations have,” Donaldson said. “They are more in favor these days and it’s because of the simplicity to form and the lower ongoing compliance issues.”
LLCs also offer more flexibility than S. corps when it comes to ownership structure, allowing for things like preferred stock and foreign shareholders.
Minimizing
Self-Employment Taxes
Feldman said there’s one main reason his clients still sometimes choose the S corp. structure: LLC owner-operators pay a self-employment tax on the money their businesses make. S corp. owners do the same, but only for a portion of the money that’s designated as their salaries. For a highly profitable company, it’s sometimes beneficial to count profits separately and avoid some of that tax. But Feldman said owners must be sure to pay themselves a fair salary, equivalent to what they’d make doing the same job elsewhere, rather than keep it artificially low to avoid the tax.
Regardless of the factors a small business owner faces, though, Rainey emphasizes that it’s important to get advice from professionals — an attorney, an accountant and probably an insurance agent as well — before making any decisions about how to structure a new business. n
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