Speaker 1: Today I want to talk about how to choose the best legal structure for your business because right now you may be wondering, Hey Sean, what's the difference between an LLC and an S Corp or a Schedule C and how do I pick? And so this video is going to be great for anyone who is starting a new business or even for people who have an existing business that has evolved over time where you may be in a position where you want to go back and optimize your business entity structure. So in this video, what I want to do is talk about why choosing the right entity is important, do an overview of the four types and subtypes of business structures and simplify which one may be better for you based on your business goals. So if all that sounds good to you, then our one little request is for you to hit the like button for the YouTube algorithm. It goes a long way in supporting our channel and helping this video reach more people like you who want to learn about these business structures. Stay Tuned. Hey there and if you're new, welcome to our channel. I'm Sean with Life Accounting, the accounting company that helps you save on taxes and build more wealth. And as always, what I'm going to do is put the timestamps down in the description below so you can skip to the parts in the video that you want to learn the most about. However, if you are new to the subject, then it is beneficial for you to watch the entire video so you walk away with extreme confidence in selecting your business entity structure. Okay, let's start off with something easy and then warm up to more advanced topics starting with number one, what is a business entity or legal structure? The easiest way to describe a business entity is that it is a structure in which you will conduct and engage in business activities such as selling goods and services. So of course, it is an important decision to make when you are starting a new business. Now if you are not proactive about selecting your own business entity, then by default, you usually will become a sole proprietor or a general partnership, which isn't necessarily a bad thing. Also, you should know that if you have already become or selected a business entity, that you can later switch to another legal structure or even elect to be taxed differently, which we'll talk about a little bit later in this video. Now a big misconception for many people is that they think you need a particular business structure in order to write off any business expenses, but this is not the case. You get the same tax deductions as you would for a sole proprietorship, as you would for an LLC or an S-corporation. As long as you identify as having a self-employed business, then you can write off almost anything. Now generally speaking, to set up a business entity structure, what you would need to do is register your business with your secretary of state where you make sure your business name is available within that state. You would also list all the partners or members associated with that business, then of course you would choose your entity type, then you'd list a registered agent to receive mail and correspondence on behalf of the business, and then you pay a small registration fee, and then you're set up. Okay, now that you understand all that and what a business entity is, let's talk about number two, why choosing the right business entity is so important. There are three big factors that you want to take a look at when deciding how to structure your company. Okay, you want to take a look at the legal protections offered by the entity, you also want to take a look at the tax treatment and potential outcomes of the entity, and the level of government required associated with having that particular entity. So you have this sort of puzzle of options that you want to think carefully through because If you select the wrong entity, then you may end up, okay, putting your personal assets at risk, or paying more taxes than you actually need to, or going through unnecessary government requirements that could be holding you back from growing your business. So you want to choose wisely so you have the best possible outcomes, which by the way, if you need help with tax planning, I have a few more appointments left that I can take and my dad who is also a part of business has some availability left as well. But we are almost done with this tax season. So go ahead and click the first link down in the description below if you need more help today. All right, let's go ahead and move on to number three, breaking down the four types of business entities. You can sum up business entities into four types. Okay, you have sole proprietorships, partnerships, corporations, and LLCs. Let's go ahead and take a deep look at each type starting with number one, sole proprietorships. So a sole proprietorship is the simplest business entity of them all. Okay. In fact, under law, if you launch a new business and you are the sole owner, you will automatically become a sole proprietor, which means you don't need to go to your secretary of state and register or file any paperwork. Although some states do require you to get a local business license or permit to sell certain particular goods and services. Now typically people who identify as freelancers, consultants, delivery drivers, independent contractors and other service professionals fall under the sole proprietorship, which is why it is the most common business structure because some people who are just setting up side hustles or side gigs are doing so without realizing they're starting a business and becoming a sole proprietorship by default. So the pros of a sole proprietorship are, okay, it is easy to set up since you don't have to register with your state plus there is no paperwork or ongoing requirements from the government and you still can take qualified business tax deductions as well as filing your taxes are less complicated and less expensive. Now the major and I mean major con of a sole proprietorship is that you have no legal liability protections because as a sole proprietor, you are personally responsible for all the debts and all the liabilities of the business. So if someone sues your business, they can try to claim your personal assets such as your car, your home, or even your personal bank accounts. So that's a really big con. Okay. Another big con of a sole proprietorship is that it is harder to build business credit since there is no legal separation between you and the business. It can be more difficult for lenders to get a full financial picture of your personal side in your business side. And since it's harder to build business credit, it is also harder to raise money or get a loan for your new business. Now I have a video breaking down how to build business credit that I'll link at the end of this video so you can check that out after you finish this one. But anyway, for these reasons, you know, the personal risk of your assets and the challenges of raising money, many sole proprietorships convert into a single member LLC or corporation. But first let's talk about number two, the general partnership or GP. So in many respects, a general partnership is very similar to a sole proprietorship with the main difference being instead of there only being one owner, there are two or more owners in the business. And just like it is with a sole proprietor, if there are two or more owners in the business, then by default under law, it becomes a general partnership. And of course the pros are very similar too, right? Like a general partnership is easier to set up because there is technically no paperwork you need to file. But of course you should still have a good partnership agreement in place. You also get all the same tax deductions that you would as a sole proprietorship and other business entities. However, I do want to mention a unique pro of a partnership, which is that there are lower business risks because now you have a partner where you are usually sharing in all the personal and business risks, right? Like you would handle legal matters together. You would split up business losses together so everything doesn't fall on one person. However, the major con of someone being able to sue your business and go after your personal assets still exists under a general partnership because there is still no legal liability protection. Okay. Another con of a partnership as well, you still have a partner. So there is less control and the possibility of internal disputes within your business. Like maybe you have a different vision from your partner that could cause some internal conflict, which could cause the business to become more stagnant. Which again is why it is so, so important to have a good partnership agreement in place. Also, when it comes to taxes, this could be a slight con as well because partnership returns require a separate tax return to be filed. And the last con of course is even after all this, you still have to split the profits with someone else. Now another type of partnership you have to choose from is number three, a limited partnership or LP. Now unlike the other two, this is an entity that you must select and register with your secretary of state. So in a limited partnership, you have two types of partners. Okay. You have a general partner and then of course you have a limited partner. The general partner acts as the manager of the business, so they will be the ones who operate and assume the personal liability of the company. Whereas the limited partner acts more so as a passive investor in the business. So the pros and cons of a general partner in a limited partnership are similar to the ones that exist in a general partnership entity overall. However, limited partners are usually not held personally liable for the company's damages, which makes it easier for limited partnerships to raise money from investors who just want to be passive. However, that major con still remains if you are the general partner in the limited partnership because you are still held personally liable for the company and now there are more costs associated with managing a limited partnership. Okay, let's move into more advanced legal structures starting with number four, a C corporation. Now, it is my opinion that the C corporation is one of the most advanced business entities that exists because it is totally separate from the individuals, both legally and tax wise. You see, most business entities are known as pass through entities, which means they are still tied to individuals at the individual tax rate. However, what makes a C corporation unique is that it has total separation for tax purposes as well. So for example, let's say you have a single filing status and you have $200,000 in business profits. Well, if you owned a pass through entity, then on that $200,000, you would pay taxes at the individual tax rate, which is a marginal 32% tax rate. However, a C corporation's profits are taxed at a specific corporation tax rate, which for 2022 is a flat 21% tax rate. So if you had $200,000 in business profits, you would pay 21% in taxes. So that's a significant difference and there are so many circumstances where becoming a C corporation makes a lot of sense. In fact, most of the largest companies in America are set up as a C corporation. So the major pros of a C corporation are you have limited liability protection, you pay a flat 21% tax rate, you're eligible for more tax deductions, such as writing off charitable donations, and you can offer stock options and shares, which makes your ability to raise money much easier. The major cons of a C corporation are there is more administration, there is more tax complexity, and there's more costs associated with maintaining a C corporation. C corporations also face double taxations when owners withdraw profits beyond the C corporation level. There are also a lot of government requirements, such as maintaining shareholder meetings and creating bylaws, and much more. I have an entire video where I break down the benefits of a C corporation, which may be really helpful, so I'll link that video at the end as well so you can check it out after you finish this one. Let's move on to the next type of corporation, which is number 5, the S corporation. Some people will argue whether or not an S corporation is a business entity or simply a tax election. But regardless of where you stand, here's how an S corp works. So an S corporation is like a blend of a C corporation. It offers limited liability protection to protect your personal assets. It also can issue stock, which makes it easier to raise capital for your company, yet it is taxed as a pass-through entity instead of having a flat tax rate. So it is a very, very flexible business structure with the major pros of being an owner or shareholder are you have personal liability protection, there is no double taxation or corporate tax rate to pay, and there is no self-employment taxes applied to your owner distributions. The cons are you are required to pay yourself a reasonable salary, and although you can issue stock, there are limits to how much stock you can issue, and you still need to comply with government requirements such as creating bylaws and holding meetings. So S corporations, at least in my opinion, are the second most powerful business entities followed by a C corporation, but that doesn't mean you should just rush and set up an S corp or a C corp because depending on where you are in your business, you may not be able to take full advantage of all the benefits associated with having these entities and they can actually cost you. There is another type of corporation that we haven't talked about, which is a non-profit corporation, but because that's in an entirely separate category, I'm going to leave that off the list for now. But hey, if you want me to make a video on the benefits of starting a non-profit corporation, just tell me down in the comment section below. The next business entity I want to mention, and you've probably already heard of it, is number 6, the Limited Liability Company, or the LLC. So if you've done any research on starting a business, then you've probably heard people suggesting that you should start an LLC, and rightfully so, because I would consider LLCs to be the most flexible business entities that you can have. Going through this list, you probably noticed all the different pros and cons associated with each entity. But an LLC is like a mixture of the best pros, such as having limited liability protection for your personal assets, you can also choose how you want your business to be taxed, whether you're being taxed as a corporation or as a pass-through entity, and there are less government requirements associated with having an LLC. And there are hardly any cons outside of the fact that you have to register your business with the Secretary of State and pay some additional annual fees. So now let's put all this together and talk about the 4th part of this video, number 4, how to choose the best entity for you. Now there are two important things I want to mention here. First, you should know the vision and plan for your business operations more than anyone else, so I implore you to do your own research and think deeply about all the pros and cons associated with having a certain business entity. Secondly, I'll be going over my list and my tiers that I help guide people towards making their own decision of which entity structure to choose. So in tier number 1, I have sole proprietorships and general partnerships. So this may be great for people who are worried about having liability protection and they want to get going quickly without having to file a lot of paperwork, as well as they don't forecast having over $250,000 in income. For example, if you are self-employed and you are working underneath a large company or a corporation as an independent contractor, then well, they may offer some additional liability protections as a company, as well as require you to have insurance policies to protect you as well, like Uber drivers. Okay, in tier number 2, I have limited liability companies and partnerships, which are great for entrepreneurs who are starting to step out on their own and now they need some limited liability protection. And this is an entity that you can grow with, so as you start making more income, you can elect to be taxed as a corporation later on. Also, this is a great place to start building up some business credit and raising some small initial capital for future business projects. In tier number 3, I have S-corporations because after you've started to gain some traction, then your business may need to do a couple of things. For example, you may have a product or service that is in strong demand and you may be struggling to keep up, so maybe you will require some additional growth capital from a shareholder and you can issue stocks as an S-corporation. Or maybe your business profits are really good and you have enough money to put yourself on payroll so that you can start avoiding self-employment taxes. In other words, I think S-corporations are great for companies that are growing and they have a need for additional capital or reducing their tax burden. Finally, in tier number 4, I have C-corporations, which are great for companies that project having a significant amount of revenue or raising a significant amount of capital from investors or shareholders. And at the same time, you are willing to make more aggressive investments back into the company while maintaining a positive growth trajectory. So that's my take on it. I think many people will fall in tier 2 and then they can grow from there. Since you made it this far, I have one bonus section for you, which is number 5, who should set up your business entity. Sometimes I get questions about, hey Sean, how should I actually set up my business entity? Should I do it myself? Should I hire a tax attorney? Should I hire an accountant? What? And those are usually the three options that people are looking at, right? Like deciding to set up your business entity yourself, hiring an experienced accountant, or hiring an experienced attorney. So of course, you know yourself and you know how much knowledge you have around the subject, so let's quickly talk about the major difference between a tax accountant and a tax attorney. So for the most part, when you go to a tax accountant to set up your business entity, then they're more than likely going to be looking at the tax outcomes and the financial outcomes of having that structure. So you may get questions like, how much money are you putting into the business? Or how much revenue do you project making? Or how many partners will there be? Will there be investors or just operators? In order for them to get a complete grasp on how your entity selection may impact your taxes. On the other hand, most tax attorneys are going to be looking at the legal outcomes associated with having various business entities. So they're going to ask you stuff like, okay, what personal assets do you have and you need to protect? Or do you plan on transferring your personal assets one day? Or what are the legal risks associated within your business? To get a full understanding of how your entity selection may impact you and your assets. Now each party, of course, will know a little bit about the tax and the legal outcomes, but of course they each have their own individual area of expertise. Okay. So I hope all this was helpful today. If it was, don't forget to like this video and then let me know in the comment section below if you have any questions. Coming up next, I have two more videos that I mentioned I would link at the end. So make sure you check those out if you haven't already, and I'll see you over there.