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The following article was published in our article directory on August 23, 2012.
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My New Home Based Business, What Will It Be: C-Corp, S-Corp, or LLC?

Article Category: Business

Author Name: James F Hughes

One of the first things most of do when starting a new business is think about a catchy name. Certainly there is some appeal to being an Inc. or an LLC, sounds more important, at least. The more serious side of the choice, however, involves the various tax and legal consequences of the decision. In this brief article, I will discuss the various forms of business organization that one may choose. I will then address some of the tax implications of each alternative. Finally, I will present my recommendation of which makes the most sense for the home based business owner who is just starting out.
Although we see an alphabet soup of letters appended to the end of business names, there are really only two, basic versions of business organization; everything else is just a permutation or a hybrid of the two. The basic forms are sole proprietorship and corporation. Originally, all businesses were organized as sole proprietorships, the company and the owner were not distinct entities; the owner was the company. The first corporations were created in Europe by royal charters when the need arose to bring together large amounts of capital, more than could be accumulated by an individual or small group, at that point the corporation came into being; an early example would be the famous East India Trading Company. The distinguishing characteristic of a corporation is that the corporation is a distinct entity, separate from the owners (in this case known as stockholders). As a side note, there has been a certain amount of political theater over the claim that corporations are people (those on the left say no, those on the right, yes). Corporations are "people" in a legal sense; a corporation can carry out many transactions, such as entering into a contract, which a natural person can. In addition to the difference in ownership, the corporate form provides, at least in theory, protection for the investors from the losses and liabilities of the business. In general, the stockholder in a corporation is only liable to the extent of his or her investment for losses sustained or liabilities acquired. For a sole proprietor, there is unlimited liability; if the business suffers a major loss, the sole proprietor can lose everything! So far the corporation sounds like a good bet; however, there is a high price to pay for limiting one's liability, as we shall see next.
When the time comes to pay taxes on the phenomenal profits from your new home based business, the choice of between sole proprietor and corporation becomes important; as a corporation, you will be taxed, essentially, twice on the same income. An example will illustrate this point. Let's say you open your business as a sole proprietor and have a net profit of $100,000 in the first year. The $100,000 becomes taxable income. In addition to your income tax you will also be liable for self-employment taxes for Social Security and Medicare. If the same business were a corporation, the company would be liable for income taxes on the $100,000 at the appropriate corporate rate. You, as owner, would be paid a salary by the corporation, which takes care of the self-employment taxes, however, any additional profits removed from the company would be treated as dividends and would be taxed a second time on your personal income taxes. At this point you may be thinking "Fine, I'll just leave the profits in the company and postpone the taxes!" Unfortunately, the Internal Revenue Service has already thought of that (and just about any bright idea you may have) there are strict regulations about when you may hold profits back; generally there must be a legitimate business need such as a major capital project. The several variations on the themes of sole proprietorship and corporation have developed to provide the benefit of limited liability while avoiding the double taxation of the corporate form.
The S-Corporation (named for the subchapter of the internal revenue code from which it sprang) has many of the benefits of a C-Corp while avoiding the problem of double taxation, the profit and losses of an S-Corp "pass through" to the owners. Similarly, a limited liability company (LLC) provides protection from liability, as the name implies, while avoiding double taxation. The key differences between the two forms are in the nature of ownership and the fact that the LLC is not "recognized" in the internal revenue code; an LLC is treated as a sole proprietorship, partnership, or S-Corp for income tax purposes. An important point to emphasize at this point is this: Every form of business organization above sole proprietorship requires significantly more complicated accounting and income tax reporting. This leads to my personal recommendations for those starting a home based business
As a practical matter, I would advise anyone starting out with a home based business to start as a sole proprietor. This may be as simple as filing a "doing business as" (DBA) with your particular state. Additionally, if you have employees an employer identification number from the Internal Revenue Service is required; states may have additional requirements. Unless the business in which you engage has substantial risks of litigation, the sole proprietorship will be easy to administer from a bookkeeping stand point and will be less likely to cause conflict with the IRS for inadvertently filing an erroneous income tax return. So, forget the "sex appeal" and prestige of the INC. at the end of your business name; keep it simple to save money an

Keywords: home based business, work from home.

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