A new year means a clean slate for business. If your business is still in sole proprietor status, now is the perfect time to start thinking about incorporating as a registered entity formation.
What registered entities should entrepreneurs incorporate as? Here are a few popular options for entrepreneurs planning to exit sole proprietor status.
- Limited Liability Company (LLC)
- Corporation
- S Corporation
- Nonprofit Corporation
Limited Liability Company (LLC)
Which type of business benefits as an LLC? An LLC is a popular entity formation, thanks to providing limited liability protection and ease in maintenance. The flexibility of an LLC makes it a popular choice among businesses of all shapes and sizes. Usually, businesses that would like to remain lean will form an LLC.
What does it mean to form an LLC? Forming an LLC provides small businesses with limited liability protection for their personal and professional assets. This creates a separation between these assets, protecting them in the event of an unforeseen circumstance.
Liability protection aside, forming an LLC affords entrepreneurs a great deal of flexibility. There are management structures in LLCs, allowing owners (members) to run their business under three different types of management. You may also choose the method in which you would like your LLC to be taxed, which is an opportunity not afforded to sole proprietors.
Corporation
Which type of business benefits as a corporation? Businesses that are interested in becoming public structures may form a corporation. Generally, these are companies that are growing quickly. They have plans to eventually go global and may even wish to take their companies public with an IPO.
What does it mean to form a corporation? Forming a corporation shares some similarities with an LLC. Both businesses do receive liability protection and tax advantages.
However, the corporate structure is much more formal than flexible. The corporation is required to comply with corporate formalities. This includes holding annual meetings with directors and shareholders, documenting said meetings with corporate minutes, and updating corporate bylaws.
S Corporation
Which type of business benefits as an S Corporation? Electing an S Corp election would be an ideal fit for small businesses and freelancers or self-employed individuals that have profits between $80,000 and $100,000.
Why are the stakes a bit higher for S Corps? Earlier I mentioned that small businesses that form an LLC may elect an S Corp for tax purposes. Technically, an S Corporation is a tax status election. Companies that are already registered as another registered entity formation, like an LLC or corporation, may choose to file their taxes as an S Corp and still receive all the advantages of their existing entity status.
What does it mean to elect an S Corporation? Electing an S Corporation is popular with entrepreneurs because it allows owners to avoid double taxation.
How does this work? Income, deductions, credits, and losses pass through to the owners. This means business owners are responsible for the taxable activity of the business. Electing an S Corp means they will not pay taxes at the corporate level, therefore being able to avoid double taxation.
Nonprofit Corporation
Which type of business benefits as a nonprofit corporation? Businesses that form nonprofit corporations are generally focusing on charitable causes. These causes must be able to benefit the public or a specific group of individuals. Businesses that form a nonprofit corporation will have these individuals in mind and be highly interested in serving their community.
What does it mean to form a nonprofit corporation? Essentially, forming a nonprofit corporation means you plan to operate the business with a charitable purpose in mind. A nonprofit corporation is eligible to apply for 501(c)(3) status. This designation from the IRS states that the nonprofit has been established for purposes of charitable, educational, or religious missions.
As a nonprofit, you will be able to incorporate as a nonprofit and create bylaws, as one would with a standard corporation. But you will also be able to establish a mission statement for your nonprofit corporation. This statement helps you define the mission and values of the organization and create actionable goals that allow it to reach its mission.
Wait! How do I know it’s time to incorporate?
Before you pick an entity formation, some sole proprietors may have questions about when it’s time to exit a sole proprietorship.
Generally, most sole proprietors start very small businesses. These businesses involve little to no risk or debt. Usually, they focus on a hobby that the entrepreneur enjoys.
However, once this hobby or small business starts to grow its customer base and expand its offerings, the company engages in business activity. It is then able to begin turning a profit. As a result, sole proprietors will feel it’s time to graduate from their default formation to a registered entity — which may include one of the entities mentioned above.
