DISCLAIMER: I, Linda Rawson, am not an attorney or accountant. I am merely giving you my opinion and lessons learned from my experiences.
Okay. Pay attention to that disclaimer as I will be referencing it again. The proper way to choose a corporate structure is to consult an expert such as an attorney or accountant.
One of the first and most important choices when starting a business is the selection of the type of legal entity your company will be. This decision will affect how much you pay in taxes, how much paperwork you will need to do, determine personal liability and impact the ability to raise money through the sale of equity.
C Corporation and S Corporations require a corporate return, corporate minutes and give you the option to establish shares to sell for equity. It sounded like a lot of high-cost record keeping work that I wanted to avoid. Nobody likes to do paperwork.
When I started, it was just me. I didn’t imagine I would be anything else other than a consultant. I thought I would be claiming all my income on my individual tax return Schedule C. I wanted simpler taxes, so I incorporated as an LLC without consulting an attorney or accountant. The State of Utah makes it so easy to incorporate. It even generates the articles of incorporation for you. Why would I want to do all that extra bookkeeping?
Then the next thing is filing with the IRS. Here is where I made a critical error that almost prevented me from obtaining my 8(a) status when I first applied. They classified me with my Employment Identification Number (EIN) as a Single-Member LLC. Single-Member LLC was great until the SBA said an LLC is defined as one or more people and we cannot approve your application unless you get this changed. I had ten days, I added my daughter as the other member, expedited the articles of incorporation, and our 100 percent Woman-Owned Small Business (WOSB) expanded to two people. That was in 2009 when our 8(a) application was approved by the SBA.
Later, after participating in the Mentor-ProtégéProgram, we used a lawyer to convert DynaGrace Enterprises to an S Corporation to have the option to sell shares if we needed to raise capital. Payment for government work can be delayed up to 90 days and as a company you have to carry that money and wait for the government to catch up. You will get paid, but it may take some time.
The main advantage to switching to an S Corporation was to minimize Social Security and Medicare taxes for myself and to limit my personal liability. The profit and losses are still passed to me utilizing a K-1form and reported on my individual return. I didn’t choose to experience the double taxation that is the downside of the C Corporation.
When I started my business, Sole Proprietorshipwasn’t talked about much but it is my understanding if you own 100 percent of your business this may be the option for you. Again please consult an attorney or accountant to figure out the best choice.
Remember in business, as in life, one size does not fit all.
It can be expensive to convert to a different corporate structure later, but it is not a critical mistake, and change can mean growth but know the facts and make the best decision at the time.