Small Business

There are various methods of creating a business entity

The following are just a few examples:

• Sole Proprietorship,
• DBA,
• LLC with or without Partnership, and
• S Corp

1. SOLE PROPRIETORSHIP:

Doing Business Under Your Personal Name:

Typically, as long as your personal name is in the business name, you don’t have to register a Fictitious Business Name otherwise known as a Doing Business As (dba).  Under this method of organization, you can simply use your social security number as your business Tax Identification Number (TIN).

This entity structure, however, exposes you to 100% of your business’ liability.

Doing Business Under A DBA:

DBA stands for “Doing Business As.” It's also referred to as your business's assumed, trade or fictitious name.

Filing for a DBA allows you to conduct business under a name other than your own; your DBA is different from your name as the business owner, or your business's legal, registered name

Most jurisdictions require that any person or business doing business under an assumed, trade or fictitious name register that name in the county in which they are doing business. This is a consumer protection law.

To be sure, this entity structure still exposes you to 100% of your business’ liability.

2. LLC:

An LLC is a limited liability company, which is a type of legal entity that can be used when forming a business that offers protection to the owner(s) from personal liability for debts and other obligations that a business might incur.

In other words, the personal assets of the owner cannot be used for legal claims against the business. This is typically a good idea for business owners who own substantial assets, such as a home, that could otherwise be subject to business liabilities.

Single-Owner LLC:

An LLC also allows pass-through taxation, meaning business income or losses are recorded and taxed on the owner's personal tax return just like doing business under your personal name or a DBA. Nonetheless, LLCs are beneficial for sole proprietorships and partnerships.

Partnership:

An LLC with multiple owners would be taxed as a partnership, meaning each owner would report profit and losses on their personal tax return.

However, in some instances, a business may be both an LLC and an S corporation.

You can form an LLC and choose to be taxed as an S corporation, but your business can also operate under the default taxation system for LLCs.

A business must meet specific guidelines by the Internal Revenue Service (IRS) in order to qualify as an S corporation.

3. S CORP:

An S Corporation's structure also protects business owners' personal assets from any corporate liability and likewise passes through income, usually in the form of dividends, to avoid double corporate and personal taxation. S Corporations also help companies establish credibility as a corporation since they have more oversight. S Corps must have a board of directors who oversee the management of the company. However, S corps are limited to 100 shareholders, unlike an LLC, which does not have limitations on the number of partners that can participate in the LLC. Moreover, S Corps can pay shareholders dividends or cash payments from the company's profits.

Like an LLC, an S Corporation not only provides limited liability protection, but also offers corporations with 100 shareholders or fewer to be taxed as a partnership.

An S corporation is also known as an S Subchapter.

S corporations are corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes.

Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates.

This allows S corporations to avoid double taxation on the corporate income.

S corporations are responsible for tax on certain built-in gains and passive income at the entity level.

Tax Implications:

Business or Hobby:

A sole proprietorship whether registered as a dba or not must show a taxable profit within 5 years

If the owner can't report the business (however formed) making a profit in three of the last five years, or produce other evidence to show profit-making intent, such as marketing activities or business development, the IRS could deem the business to be a hobby, not a business, and deny tax benefits.

That is, you can only claim a business loss in three of the last five years in business

Businesses using Schedule C:

Can deduct Business Expenses

Thus, the IRS may designate your business as a Hobby

If your business claims a net loss for too many years, or fails to meet other requirements, the IRS may classify it as a hobby, which would prevent you from claiming a loss related to the business.

If the IRS classifies your business as a hobby, you'll have to prove that you had a valid profit motive if you want to claim those deductions.

Preventing your business from being classified as a hobby

Running a hobby as a business could very possibly trigger an IRS audit.

If your business is legitimate, keeping accurate and extensive records could help prevent the classification of your business as a hobby.

In addition to demonstrating your professional approach to your business, records and receipts can help document your profit motive.

Formalizing your business under a Business Entity structure can demonstrate a profit motive

Self-Employment Tax:

Generally, your net earnings from self-employment are subject to self-employment tax.

If you are self-employed as a sole proprietor or independent contractor, you generally use Schedule C to figure net earnings from self-employment.

If you have earnings subject to self-employment tax, use Schedule SE to figure your net earnings from self-employment.

Before you figure your net earnings, you generally need to figure your total earnings subject to self-employment tax.

The self-employment tax rate is 15.3%. The rate consists of two parts: 12.4% for social security (old-age, survivors, and disability insurance) and 2.9% for Medicare (hospital insurance).

LLC:

LLC members are not employees so no contributions to the Social Security and Medicare systems are withheld from their paychecks. Instead, most LLC members are required to pay these taxes -- called "self-employment taxes" when paid by a business owner -- directly to the IRS.

LLC owners choose to lessen their individual self-employment tax burden by electing to have the LLC treated as a corporation for tax purposes. Classification as an S Corporation (under Subchapter S of the Internal Revenue Code) is what most LLCs select when aiming to minimize their owners' self-employment taxes.

S-Corp:

If you organize your business as an S-corporation, you can classify some of your income as salary and some as a distribution.

You'll still be liable for self-employment taxes on the salary portion of your income,

but you'll just pay ordinary income tax on the distribution portion.

Depending on how you divide your income, you could save a substantial amount of self-employment taxes just by converting to an S-corporation.

Thus, the S Corp advantage is that you only pay FICA payroll tax on your employment wages.

The remaining profits from your S Corp are not subject to self-employment tax or FICA payroll taxes.

Those profits are only subject to income tax.