Creative Commons License

Creative Commons License

People always want to know if they should incorporate their business.  It depends on what you are doing and how you are doing it.  Generally, in the wedding industry, most businesses do not require incorporation.  There are some good alternatives to structure your business once you have established yourself and are making money.

There are five types of structures for your organization.  They are: sole proprietorship, partnership, corporation, S-Corporation, Limited Liability Corporation.  They mainly differ in the tax benefits afforded to your business.  Keep in mind, it’s beneficial to talk to a tax professional and/or lawyer to determine the best structure for your business. Let’s break them each down and see which one is right for your business and your personal circumstance.

Sole Proprietorship

If you are just starting your business, this is usually where you begin.  A sole proprietorship is a company that is owned by one person.  These are its characteristics:

  • Owned by an individual who also runs and manages the organization
  • The business income and taxes are taxed on the owner’s tax return (this is the individual tax return 1040); You are required to file a Schedule C as part of the 1040 (no separate federal tax requirements)
  • Easy to set up; Easy tax reporting
  • Great for start-ups who have losses in early years; Losses can help offset other forms of income (for example, if you have a job while you are starting up your business, the startup costs can decrease the tax you pay on your salary)
  • Your personal assets are at risk for liability (if your business goes bankrupt, the bank can repossess your home)
  • If you plan to get financing from a bank or investors, it may be a little challenging depending on the amount; banks are reluctant to lend to sole proprietorships unless you have collateral (your home or other asset)

Partnership

A partnership is a business that is owned by two or more individuals.  You can either form a general partnership which means that the owners also operate the business.  They are also responsible for the liabilities (debts) of the business.  Or, you can form a limited partnership that typically has general and limited partners.  (The general partners operate the business while limited partners serve only as investors having no operational control over the company.)  These are a partnership’s characteristics:

  • Partnership is not taxed; the individuals/partners are taxed (this is similar to a sole proprietorship where the taxes are paid by the individual, not the business)
  • Fairly simple to set up; a partnership agreement is necessary
  • Start-up losses can set off any other forms of income (similar to the sole proprietorship)
  • General partners’ assets are at risk for liability

Corporation

A corporation is an individual legal entity.  It is completely separate from its owners.  If you establish a corporation, you are an owner of the organization.  If you work in that company also, you are an employee of the organization.  You now fill two separate roles and your company is completely separate from your personal income and taxes.  Here are some characteristics:

  • Biggest benefit is the protection from liability (if you the business goes bankrupt, or if you are sued, “they” can’t go for your home or personal assets; however, some banks require that owners sign a personal guarantee)
  • More regulation and tax requirements than a sole proprietorship or partnership
  • A corporation can sell stock to raise money; the company is now owned by several people, many of whom have no operational role in the organization
  • More costly than a sole prop or partnership (attorney and accountant services are needed for counsel on legal and tax requirements by each state)
  • The owner(s) of a corporation can be taxed twice: once at the corporate level (the company’s net income) and again in dividend distribution (when earnings are distributed to the owner(s).  This can be avoided to some degree as salary distribution (an expense which offsets the company’s net income).  However, an owner who also works in the business will be taxed at the corporate level and also as an employee (corporate tax and payroll tax).

S-Corporation

An S-Corporation is similar to a corporation in that the owners are protected from personal risk.  The major difference is that income and losses are passed to the owners of the company and reported on their tax returns.  There is no taxation at the corporate level.  (This avoids the double taxation that happens with a corporation.)  Here some additional characteristics of an S-Corporation:

  • Can have up to 75 shareholders making it possible to raise more money for your business
  • Similar to a corporation, the S-Corp is more costly because of tax and legal requirements (more attorney and accounting services and fees)

Limited Liability Company (LLC)

A Limited Liability Company is a corporation that allows business profits to pass on to the owners (similar to the S-Corporation) thereby avoiding the double taxation.  Here are some of its characteristics:

  • The LLC differs from an S-Corp in that there is no limit to the number of shareholders.
  • This is similar to a limited partnership but there is a protection of the individual against liability risk and limited partners can also have an operational role.
  • LLC tax treatment can differ by state.
  • LLCs can be more costly due to legal and accounting advisors,

Generally, you will begin your business as a sole proprietorship or partnership.  When you start to seek outside financing or investments you will want to consider the benefits of incorporating (or forming an S-Corp or LLC).  I’ve spoken with several professionals in the wedding industry who want protection beyond what is inherent to their business insurance.  These businesses have organized as a corporation or an LLC.  These two structures can protect your personal assets from a bridezilla or groomzilla who decides to sue your pants off.  It’s good to revisit these structures from year to year.  As your business grows, your tax implications change and your risks transform.