Which Business Entity and Why?

Les Robertson

Les Robertson

Guru of Steel
For those of you who consider yourself a business. Which business entity are you set up as:

Sole Proprietorship

LLC (Limited Liability Company)

"S" Corporation

"C" Corporation


For those of you who are "hobby" maker's do you include your sales as part of your personal income?
 
I've been thinking about writing a tutorial about this very subject because we're talking about it right now in my taxation class. I've got an exam over it on Tuesday, and will try to start writing after that. Short answer, there is no good reason to be a sole proprietor except for set up costs because you are personally liable for both debts and negiligence suits, LLC would be fine but you're still personally liable for business debt, and an S-corp better because business income is only taxed at the personal level and the business is liable for both debt and negiligence. There's no reason to set up as a C-corp either unless you reinvest all of your income into the company (i.e., you don't get any cash). Otherwise it is taxed at the entity level and also at the personal income level (your salary). I am a "hobby" maker and do not include sales as personal income. As long as it is a "hobby" this is ok, but the crossover from hobby to business is fuzzy and the IRS might be less understanding than you'd like. If you want to count your expenses as business deductions, you'd better be including your sales as income.

Again, I'm planning to write up something more comprehensive after a conversation with my tax professor about the issues specific to our trade. I hope this helps, a little.
 
to be entirely frank.

at this point I am a Sole proprietorship, simply because I haven't taken the time to go to my tax guy and figure out the S corp.

When I used to be a Trim carpenter I was set up as an LLC.
 
What Travis says is correct, kinda. As a word of introduction, which I did not include in my profile, I practiced law in Georgia for 35 years and did advise clients as to their form of business. So here goes my opinion , you will notice that I did not say advise. I am retired now, and not licensed to give “advice”.
These are my opinions and as such I am not liable if you use it.

As Travis said, if you are a sole proprietor you are personally liable for both debts and negligence , both business and personal. As to debts, even if you are a closely held corporation, LLC or what ever and want to borrow money or otherwise incur debt the creditor will probably require that you personally guarantee their extension of credit, so you might as well be a sole proprietor. As to the negligence, what negligence. If you make a knife and it breaks? The measure of damage might be the value of the knife. If you make a knife and it breaks and therefore cuts the user, maybe, maybe you might be liable,,, if it can be shown that you were negligent in the construction or making. Even then, if the injured party is going to sue, he is going to sue the corporation, LLC, or whatever, and you personally. If you are worried about this buy insurance. By the way, your Homeowner’s policy will probably not cover this. Get an umbrella policy or a business policy.

Never, never enter into a Partnership. In a partnership, you and all partners are equally liable for partnership debts and negligence to the extent of the partnership and you personally. That means that if your partner is driving his pick-up, on partnership business, and has an accident, and he is at fault, the partnership is liable, he is personally liable, and you are personally liable. He causes an accident and suddenly your home and everything else you have or might ever have is at risk. This is even if you own 90% of the partnership and he owns only 10% the judgment can be collected 100% from you. AND you can bet if the attorney knows that you and he/she are involved in a partnership he is going to claim that your partner was on the business of the partnership. So if you did not understand it when I said Never, never above let me stress NEVER!!!! enter into a partnership. Another word of caution about a partnership: When one of the partners dies the partnership dies, the assets of the partnership must be distributed between the surviving partner, or partners, and the heirs of the deceased partner. This can be a mega problem if the heirs want to sell all assets and distribute the cash and you don’t have the disposable cash to buy them out (unfortunately, the heirs are not knifemakers and don‘t want all of that knife making stuff). If you have a corporation with other share holders and a share holder dies the corporation lives on. Now, unfortunately, you may have fellow share holders who are not knifemakers, do not contribute to the business but want their share of the money that you have made. This is just more problems. In either case, if you insist on doing business with someone else, have a Buy Out Agreement and fund it with life insurance.

If you form a corporation, LLC, or whatever, you have just doubled your book work, accounting fees and exposure to the IRS. You must be very careful to dot every i and cross every t. Everything has to be kept separate, your personal books and money and your corporate books and money. If you are at the grocery store and at the check out the ticket is $101.00 and you only have $50.00 cash with you and $25.00 in your personal account, but have $10,000.00 in the corporate account you can not pay for those groceries with a check on the business account. That is not your money, it belongs to the corporation. You could, of course, write a check from the corporation to you, deposit it in your personal account, then write the check from your personal account, or even, if the grocery store would accept the check written on the corporation to you, you could endorse it and tender it to the store.

Lastly, if you make any money the IRS wants their cut. It does not make any difference if it is “Hobby Income”. If you get a scholarship from a Knifemaker group, or Blacksmith group, or win the lottery, they want their cut.
 
Since I've only got half masters in accounting (not tax accounting) with only half a tax class and one business law course behind me related to this subject, I certainly defer to Wayne and his experience on this. I'm not an expert, but wanted to help folks out with what I'm learning in school. It looks like I missed it about the income from hobbies, though I suppose if you are just doing this for a hobby then the money you make is plowed back into the hobby for no net gain. The line between hobby and business is probably drawn at the point where this ceases to be true. If you start making money at your hobby, you are by default a sole proprietor. You should definitely keep good records of your expenses and incomes, and receipts if you can to make things easier later. I would add would be my wholehearted emphasis to everything he said about partnerships. I'll still have that talk with my tax professor to see if there is anything she would add, but I'm pretty sure Wayne said everything I'd have come up with. Thanks! I hope this has been/will be helpful.
 
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Hi Travis,

A hobby becomes a business the second you decide that you want to receive payment for something produced within your hobby.

I wrote an article in Blade earlier this year about Business Entity's.

Yes, there is additional paperwork involved. That is what your account is for. You will be amazed at the reduction in taxable income you have when you incorporate the "losses" into your tax return. Your Accountant can explain all this to you.

If you have sold 1 knife and have not set up a business entity outside a sole proprietorship...you are giving the Government more tax dollars than you should. Ask yourself the simple question....Would I prefer to spend my money or give it to the government to spend?

I have a Masters in Business Administration. I have been through the H&R Block Tax Course...I was even hired by a couple of years ago. I have taken an additional 200 hours in tax courses offered through H&R Block. I say that to tell you...I still have a CPA do my taxes every year. They are professionals whose job it is to provide their clients with the best tax strategy available.

Oh, and it is a tax write off for my Corporation.

If tax payers understood all the benefits available to them by simply following the IRS Code. Then implementing strategies that are completely legal and will not trigger and audit, etc. No one would try and cheat on their taxes.

No, it is not too late to incorporate this year and get all the advantages of starting a new business.

Oh, don't ask your neighbor, brother-in-law, Wayne or even me...hire a professional.

Remember free advise is worth every penny you pay for it.
 
I'm set up as an LLC. I went this way to help protect my personal assets. I also have business insurance to help protect my little business. I work out of my garage and guess what would happen if a fire started? My home insurance wouldn't cover it! The business insurance I have insures the garage and liability and many other things I didn't even think I would need! :D
 
I am set up as an LLC.. Simply put.. My accountant told me to go that way... His view was that it is simpler and lest trouble to maintain an LLC than an "S" Corp..

So, That's what I did..

By the way.... I have a really good accountant!!!
 
Sub chapter "S" Corp.
There are advantages for Sub S in the area of raising capital through private offering of stock, limiting income through payroll and taking income as disbursements, and of course as mentioned above, liability advantages. Find a good CPA who specializes in small business and is willing to spend time with you throughout the year and not just write your return in April. A good CPA will help guide your business financially making you more money and keeping you out of trouble. If you find yourself having to drag information out of him/her, get a new CPA. Don't be suprised if you have to go through 4 or 5 before finding a good one.
Just my 2 cents.
 
Sole proprietorship is best i must say as in parntership a lot of agreements are to be made with partner and a lot of limitations are there in partnership but in sole proprietorship there is no limitation, entire business is under your control and you are your own boss. I would always prefer sole proprietorship.


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business coaches
 
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Insurance, as Wayne said, is the best protector against liability of any kind. Whatever kind of business entity you have, insurance can protect you (not talking about fraud here). Insurance companies pay lawyers so you don't have to suffer the expense of hiring a lawyer. Believe me, it will cost you more to defend a law suit than paying insurance premiums for a long time. And, if you have to hire your own lawyer to defend against a law suit, you have lost money, even though you may win the suit. Ask me how I know....
 
hi,
i am going the sole proprietorship route. here in NC it is a visit to a notary and $21, then once registered, a form to the state for a tax number. I was advised by the small business incubator at the college here that this should be all I would need until I got to a point where I am hiring employees or want to expand on a large scale.
scott
 
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