I’m frequently asked by start-up companies whether or not they should incorporate. My answer is always “that depends”. The best place to start when thinking about whether or not to incorporate is with the different types of incorporation structures.
The easiest way to become a business with the ability to open a separate bank account is to file for an assumed name certificate with your local county clerk. Assumed name certificates, often referred to as a DBA (doing business as) cost just $40 with the Travis County Clerk, and they are simple to file http://traviscountyclerk.org/eclerk/Content.do?code=R.13. You can take that certificate to the bank of your choice and open an account, which will make it easier to track your income and expenses. You can also procure an Tax Payer ID with your DBA, that way when clients or vendors ask for your W-9 you no longer have to provide your social security number. You can obtain in EIN here: https://www.irs.gov/businesses/small-businesses-self-employed/apply-for-an-employer-identification-number-ein-online
It’s important to note-A DBA does not give you the tax breaks or the protection of incorporation; you still file under your own social or tax id that is connected to your social, and you are still subject to the self-employment tax. Depending on your income and the field you work in it may make more sense to add additional protections and tax breaks.
An LLC (limited liability company) gives you the protections of incorporation without the rules that govern S-Corp or C-Corp structures. As a limited liability company the owner isn’t liable for the debts of the business, as long as that debt is in the business name. Similarly, an LLC offers legal protections for litigation brought against the company and may shield an owner from loss of personal property.
In a SINGLE MEMBER LLC the owner may take money out of the company as needed with no restrictions. The LLC structure also allows owners to pass through any profit (or loss) to their personal tax forms, thereby avoiding a “double tax” on profits made by the company. An LLC costs just over $300 and can be secured form the Secretary of State website. You can also hire a professional (like me, or a lawyer) to incorporate an LLC for you for a nominal fee. Again, LLCs don’t provide the tax protection of an S or C corp, so you will still be subjected to the self-employment tax.
In a MULTI-MEMBER LLC the owners must take draws commiserate with their ownership splits and balanced with other partners. Profits and losses are passed to the partners commiserate with their ownership split as well. This allows partnership LLCs to avoid double taxation. Partnership returns are called Form 1065 and are separate from each partners personal return. Remember to file your partnership returns before you file your 1040 or you’ll start getting the dreaded letters form the IRS.
S-Corp structures are more complex. The “S” Corp can be elected by filing a 2553 form on or before 3/15 of the year if you are already an LLC. This structure will basically mean that you MUST pay yourself a “reasonable salary” and pay payroll taxes on that salary. This is an important step to take when your business begins to have net profits that exceed one hundred thousand dollars per partner, give or take. While filing the payroll taxes may seem like a burden, the point of this structure is to shelter your profits from the dreaded self-employment taxes, which can exceed 30% or more. You may still take draws under this structure, but your salary must make sense in balance with those draws.
C-Corp structures are even more complex. In a C-Corp owners must be paid through payroll and the company must contribute to Medicaid, Social Security and state and federal unemployment tax, however, draws are forbidden. If a shareholder must pull money out outside of the payroll structure it has to be done as a loan. The profits are taxed at the corporate level and all profits then are taxed again at the personal level to the shareholder. C-Corps may be useful to large companies looking to mitigate their profits with payroll expenses and pay into certain types of retirements for their shareholders.
The S-Corp and all INC structures also change your due date for taxes, both when they are on time and when they are extended. The new date for on-time filing changes from 4/15 to 3/15, and the final extension date changes from 10/15 to 9/15. This only applies to the business tax filing, which will be separate from your personal filing date. The personal filing date will remain 4/15 and 10/15, respectively.
Generally speaking, a new start-up company would do better under the LLC incorporation structure in most circumstances. If you feel like you might be ready to incorporate, don’t hesitate to call me or whatever professional tax advisor you use to get all the facts before you move ahead. As with all things related to business, doing your homework on this issue really pays off.