Before you start your own business, you have to decide, by law, the legal formation you want for your business. This is also called “business structure” and “legal structure.” Sole Proprietorship vs LLC, DBA, and Corporation. Which one will be the best fit for your business?
Each business structure has different features, pros, and cons. And picking the right structure for your business will allow you to manage three important elements: liability, taxes, and complexity. The good news is you don’t need to be a lawyer to decide on your legal formation. It can take more or less time and cost more or less money, depending on the structure of your choice.
Keep in mind that each of the legal formations takes very different approaches to taxation.
What is a DBA?
Before we start analyzing and understanding business structures, we need to understand the term DBA and explain that a DBA is not a legal structure.
DBA is an acronym for “Doing Business As” and refers to the difference between the legal name of the business and the name by which it operates day-to-day, the name by which customers and associates may know the company (the DBA). Some states do require businesses to register the DBA name before they can begin using it, such as California and Florida.
A DBA is not a legal structure but rather a way to allow a sole proprietorship to have a business name without filing an LLC or Corporation. While simple and inexpensive, it comes with the same risk as being a sole proprietorship or general partnership.
Business Structures at a Glance
Now, let’s review in detail each of the legal formations you can choose for your business: Sole Proprietorship, Corporation, and LLC.
|Sole Proprietorship|| ||Recommended||Simplicity||Personal assets may be at risk|
|C Corporation|| ||Recommended||Owners are not responsible in case of legal trouble||Complexity (administration, taxes)|
|S Corporation|| ||Recommended||Simplicity in taxes and owners are not responsible in case of legal trouble||Not every company is eligible|
|LLC|| ||Recommended||Simplicity in taxes and owners are not responsible in case of legal trouble||Self-employment taxes|
What is a Sole Proprietorship?
By default, unless you file otherwise, your business will be structured as a sole proprietorship, which means there is one owner. This is the simplest business structure to form.
If you are self-employed or, as previously mentioned, not yet determined a business structure, then this is your default.
The biggest advantage to operating a sole proprietorship is that it is very simple to form and maintain. And, since there isn’t a delineation between the business and the owner, any income earned by the business is earned by the owner, so no separate taxes need to be filed. One would simply need to keep track of monies earned and file Schedule C with the personal tax returns.
A sole proprietorship means there is not any separation between the business owner and the business. What does this mean, exactly? Essentially, it means that if someone sues your business or if your small business defaults on any loans, your personal assets (home, cars, personal bank accounts), can be on the hook. This is why the limited liability company llc and the C Corporation (or, simply Corporation) are popular business structures, as they limit the personal liability of the owner.
Before we continue with the other legal formations, you may want to learn if it is time for you to convert your sole proprietorship to another type of legal formation.
What is a Corporation?
A corporation is considered a separate entity from its owners. Therefore, the owners will not be held responsible for any financial hardships or lawsuits filed against the business. This protection is often called a “corporate shield,” as it shields the owners’ assets.
It may be seen as though from a taxation standpoint, a C Corporation is not the way to go, and in many cases, that may be true. However, one thing to consider, especially if you intend to grow your business significantly and therefore invest profits back into the company, is that a C Corporation only pays taxes on those profits distributed to their shareholders.
Meanwhile, members or owners of an LLC, an S Corporation (both of which will be addressed shortly), and a sole proprietorship pay income taxes on any profits, whether they are deposited into personal bank accounts or invested back into the business. Also, remember the corporate shiel mentioned above. You won’t be held responsible if your business falls into legal trouble.
This business structure is often seen as overly administrative for the average small business. The reason being that this entity requires a formal structure of shareholders, directors, officers, and employees. Each corporation is required to appoint at least one person to serve on the board, and the officers are required to oversee the business’s day-to-day operations. This is generally only a good option for a small business that has been around for a while and is preparing to go public or grow significantly.
For tax purposes, a corporation files its own taxes, separate from those of the owner. As such, if you are the owner of a corporation, you will need to file both your personal taxes and taxes for your small business. In turn, this can result in “double taxation,” which means that the business pays taxes on any profits, and the owner pays taxes on those profits after they have been distributed to them. If you need more help with the documentation you can also contact a registered agent.
What is an S Corporation?
If you opt to be legally formed as a Corporation, there are two types: a C Corporation (explained above) and an S Corporation. To sidestep this double tax burden, some small business owners will form an S Corporation. This means that the business does not file its own taxes, but rather profits are passed through and filed on the individual taxes of the shareholders.
If any of the shareholders are employees of the company, then the business must pay a fair wage to those employees, aside from their profit shares and payroll taxes on the aforementioned wages.
Additionally, it is important to keep in mind that not all C Corporations will qualify for S Corporation status. For example, an S Corporation cannot have more than 100 shareholders, and they must all reside in the United States.
What is an LLC?
A limited liability company LLC is essentially a hybrid of a C Corporation and a sole proprietorship. So, to understand the difference between sole proprietorship vs LLC, the answer would be: it depends. Here are some pros and cons of this business structure:
There is a reason why this is generally the most popular business structure among small businesses. Much like a corporation, it protects the owner’s personal assets without requiring the same level of administrative oversight or paperwork to file. Additionally, you have more flexibility with an LLC as to how you are taxed: you can choose to either be taxed as a C Corporation, where the business files taxes separately, or as an S Corporation, where the profits are passed through to the owner, who then reports them on their personal taxes.
Every state has its own laws regarding the formation of an LLC; however, unlike requirements for establishing a DBA, no state requires a business to form an LLC. Rather, it is completely voluntary and a choice made by the business owner regarding whether it’s a solid decision for them.
If you (and, if applicable, business partners) own an LLC, you are not considered employees but members. As such, you do not have to pay Social Security or Medicare taxes on your profits. However, if you actively work in the business and earn a salary, then you will need to pay self-employment taxes on that income. However, with a corporation, only salaries are subject to taxation; profit sharing is not.
If your small business employs paid staff and you are committed to offering competitive benefits, then this is another area in which you will want to carefully weigh the differences between an LLC and a Corporation. There are some benefits, such as retirement plans, that are only available to corporations, while an LLC will be expected to pay taxes on certain benefits, such as health and life insurance.
Business Structures: FAQs
Is DBA and sole proprietorship the same?
Technically speaking, no. A sole proprietorship is a legal structure (like LLC or Corporation), and a DBA is not. A DBA is a legal requirement to operate your business with a trade name or a pseudonym different from your registered legal name.
Do I need to file a DBA for a sole proprietorship?
While a sole proprietor is required by law to use his legal name to conduct business, the use of a DBA, however, is optional. If a sole proprietor wants to use a DBA, he must first obtain permission from local authorities.
How many DBAs can a sole proprietorship have?
A sole proprietorship can have more than one DBA and can have DBAs in more than one state, as long as the names are properly registered before use. However, keep in mind the associated filing costs for each DBA.
Which is better: sole proprietorship vs LLC?
It depends on the degree of liability you are willing to take. In an LLC, the member’s liability is limited, depending on the amount of their investment in the LLC. Therefore, the members (or the owner) are not personally liable for the company’s debts, while a sole proprietor would be liable for them.
Is a single-member LLC the same as a sole proprietorship?
No, technically speaking, they are not the same. In a sole proprietorship, the company and the owner are one and the same in terms of taxes and legal matters, while a single-member LLC provides a divide between the Company and the owners in both tax and legal matters (the business and the owner are considered separate entities).
Can you have an LLC and be a sole proprietor?
Yes, that would be considered a single-member LLC (but NOT a sole proprietorship). The main feature of a single-member LLC is that the owner can choose to be taxed as a sole proprietorship or as a corporation.
What are the benefits of having an LLC?
The main benefit is that an LLC limits liability for the members, therefore offering more protection than a sole proprietorship. The second main benefit is pass-through taxation: the business profits are distributed to the members, who report them in their personal taxes.
With the Correct Business Structure, Success Awaits!
Just as every small business is different, so will the best option for said business. And, yes, as your company grows and changes, you can change the business structure. Consulting a respected, trustworthy tax attorney or business advisor is a good first step in determining which business structure will be the best option for you.
Once you’ve decided which legal structure and name you’ll choose for your business, the next step is to create a brand for your company. Here you can learn how to do that:How to build a brand to transform your small business