Business Entity Choices

All right. So let's go over the types of business entities 0:00 available to you for the formation of your company in the United States. 0:03 Now, for those of you who are watching but aren't in the United States, 0:07 the business entities in your country aren't in my area of expertise, 0:10 so I won't be covering them in this video. 0:14 However, I've provided some resources in the notes below 0:16 that should enable you to come to an educated decision on your own. 0:19 For the different kinds of entities in the U.S., 0:23 we won't go into detail on all the types 0:25 because some aren't so relevant to running a freelance business, 0:27 but we'll cover them, nonetheless. 0:31 Now, the most basic business entity is a sole proprietorship. 0:33 There is next to no paperwork to fill out, 0:37 and most states recognize you as a sole proprietorship 0:39 if you're conducting business, even if you don't think of yourself as one. 0:42 In a sole proprietorship you, the owner, 0:46 are responsible for all business transactions 0:49 including any debts and liabilities owned by the business. 0:52 Sole proprietorships exist as long as 0:55 the owners are engaged in the business 0:58 and can even pass on this business to their heirs. 1:00 They also don't have to file any separate business taxes. 1:03 All taxes on income earned by the business 1:06 are filed along with the owner's personal tax returns. 1:09 Sole proprietorships are quite simple, 1:12 but they do offer a few advantages. 1:14 You retain complete control of the business, of course, 1:16 which is one of the reasons you got into freelancing. 1:19 But as long as the company consists of only you, 1:22 you'll have that advantage regardless of the company's structure. 1:24 There are also very minimal costs associated with 1:28 having a sole proprietorship and no corporate tax payments or fees involved. 1:30 There are certainly downsides as well, though. 1:35 Because all the money earned in the course of your business 1:38 is filed with your personal tax returns, 1:40 you will be paying self-employment taxes on that entire sum. 1:42 On top of that, sole proprietorships don't offer any liability protection. 1:46 If you run a freelance business, chances are you already are a sole proprietorship, 1:50 but since it doesn't really offer much in the way of protection, 1:55 and tax savings, we're going to look at some of the other entities. 1:58 A partnership is another popular structure for small businesses, 2:02 but it is one that's ideal for when two or more people 2:05 go into business together. 2:08 In our scenario, we're still solo freelancers, 2:10 so partnerships don't fit in well with our model either. 2:13 Then we have corporations. 2:16 A corporation, in contrast to a sole proprietorship, 2:18 is a business entity that is a completely separate entity 2:21 from the owners of the company. 2:24 It can have from one owner to an unlimited number of owners, 2:27 who don't have to be involved with the running of the company. 2:30 Corporations are separate taxable entities, 2:32 which means that you as an owner or stockholder 2:36 are entirely independent from the company. 2:39 Corporations provide all the flexibility that you would need 2:41 as a freelancer, but there is a downside. 2:44 Corporations are the most expensive to set up, 2:47 and the costliest to maintain. 2:50 You also have all this unnecessary paperwork burden 2:52 that you have to submit to the relevant authorities every year. 2:54 That is unnecessary overhead for more flexibility than we would need. 2:57 Remember, part of running your business 3:01 is keeping those costs low whenever possible. 3:04 Then we have LLCs. 3:07 LLCs are a very popular choice of business entity for freelancers. 3:09 LLCs are far simpler than corporations 3:13 and are great for people looking to start a business 3:17 with minimal hassle and fewer formalities. 3:19 Similar to corporations, LLCs may have 3:22 an unlimited number of owners, called members. 3:25 LLC stands for limited liability corporation and, 3:28 as you probably guessed, this means it offers 3:32 the limited liability protection that corporations enjoy. 3:34 In terms of taxes, LLCs are flow-through entities for tax purposes. 3:38 This means that any taxable income earned by the company 3:43 is passed on through to the individual members 3:46 and is taxed only once. 3:49 These taxes aren't distributed as wages but as a profit distribution. 3:51 Unfortunately, in an LLC taxes are paid on any profit earned by the company. 3:56 So, regardless of how much you take out 4:02 as a profit distribution, 4:04 you'll be paying taxes on the whole amount rather than just your share. 4:06 The last structure we're going to look at is an S corporation. 4:10 S corps, as they are commonly known, are corporations 4:13 that elect to be taxed under the subchapter S specifications 4:17 of the Internal Revenue Code of the IRS. 4:21 This gives the corporation certain additional characteristics. 4:24 Shareholders of an S corporation 4:28 report the flow-through of income and losses 4:30 on their personal tax returns 4:33 and are assessed tax at their individual income tax rates 4:35 instead of being taxed like a corporation. 4:39 This allows S corps to avoid double taxation on their corporate income. 4:42 In simple terms, the owners pay the taxes 4:46 on the profits of an S corp. 4:49 Unlike LLCs, however, the owners are only paying taxes 4:51 on their share of the profits. 4:55 An S corp is a subset of a regular corporation, 4:57 and as a result offers the same limited liability protection 5:00 that regular corporations do, thereby reducing the risk 5:04 that the owners bear. 5:07 In addition, S corps can lower what the company pays in taxes 5:09 since you can pass the income through to the shareholders. 5:12 S corps still have the paperwork burden, 5:17 higher cost, and complexity of running a corporation, 5:19 but they provide for a compelling business entity 5:22 because of their tax advantages and liability protection. 5:25 So, to summarize, we're going to go with either 5:29 an LLC or an S corp for our freelance business. 5:31 For you to make a decision regarding 5:35 what structure you should pick between the two, 5:37 you need to evaluate which one provides the best 5:39 tax advantages for you in comparison to the cost of running it. 5:41 This is where you talk to tax professional or an accountant. 5:45 The laws vary from state to state, and it's probably best 5:49 to let an expert advise you on this. 5:52 Regardless of the choice, here's how you go about doing it. 5:54 First you research the entity within your state or locale. 5:58 The advantages and disadvantages I provided 6:01 apply to the generic structures. 6:04 Your state could have certain restrictions on some of these 6:06 or have more benefits piled on. 6:09 Make sure you understand what the entity means in your state. 6:12 Talk to a tax professional about the tax benefits you get 6:16 from creating that specific business entity 6:19 versus any of the others. 6:21 Fill out the paperwork. 6:23 The traditional way to go about this is to go the state office 6:25 and fill out any forms. 6:28 There are plenty of solutions on the web, of course. 6:29 Check out LegalZoom or BizFilings. 6:32 It's relatively cheap and gets the job done with fewer hassles. 6:34 Gather all the documents you need to apply for a business bank account. 6:38 Remember, one of the reasons you created a company 6:42 is to keep your personal and business finances separate. 6:44 If you filed for an LLC, for example, the bank will ask you 6:47 for your articles of organization and the operating agreement, at minimum. 6:51 Once you have your company's structure and business bank accounts, 6:56 you can go about doing everything as a company. 6:59 You can issue and sign your contracts, invoice clients, 7:03 and collect payments rather than as an individual. 7:05 This provides a nice barrier of safety, allowing you to go about your business 7:09 without worrying that you might lose your home. 7:13