A small business LLC or Inc is a business entity that is legally separate from its owners. 3 min read updated on February 01, 2023
A small business LLC or Inc is a business entity that is legally separate from its owners.
Definition of an Incorporation
Incorporating a business results from switching from either a sole proprietorship or partnership entity to a business that is officially known by the state in which it is incorporated. Essentially, the business becomes its own entity, legally separate from its owners.
Typically, an incorporated business is one of the following types of entities:
- Limited Liability Company (LLC)
- Corporation
Regardless of the type of incorporation, advantages include:
- Protection from personal liability
- Strengthened reliability with customers
Although there are many advantages of incorporating a business, there are also disadvantages to consider with each type of entity.
While LLCs and corporations are operated and taxed differently, they are both created by completing specific forms with the applicable state, and they both provide a shield for the owners in the event that the company faces legal or financial struggles.
Definition of an LLC
LLCs are not given a distinct tax designation. A single-member LLC will typically be taxed similarly to a sole proprietorship, and a multi-member LLC will be taxed as if it is a partnership.
Owners, or members, will report the business's earnings and expenses on their individual tax returns, which results in the members paying taxes on their allocated portion of the income.
LLC members can also opt to be taxed as a C corporation or an S corporation, as long as it meets the applicable requirements.
Creating a Sole Proprietorship
A sole proprietorship is the most simple formation process available for businesses. The only step required in forming a sole proprietorship is acquiring the proper permits and licenses required by the state in which the business is located.
Sole proprietorships do not cause the business to be legally separate from its owners.
If a sole proprietor wishes to change to an LLC or corporation, he or she must submit the proper paperwork to the appropriate state agency.
While costs vary with each state, a filing fee is required when forming an LLC or corporation.
Managing and Maintaining a Sole Proprietorship
Sole proprietorships are very low key when it comes to the operation and maintenance of the business because the owner does not have to stress over the details of how to structure and run the business.
When forming a corporation, most states require that owners perform the following actions:
- Establish bylaws
- Elect officers and a board of directors
- Maintain yearly files pertaining to influential meetings and decisions
Other requirements include paying the fee to file annual or semiannual reports to the state concerning any new company details.
The necessary conditions for managing and maintaining an LLC are more complex than a sole proprietorship's but easier than a corporation's.
An LLC is not required to report important company decisions and updates like a corporation, but it is mandatory that it file scheduled reports containing any new business information.
Tax Filing Requirements for a Sole Proprietorship
A sole proprietorship and its owner are considered one entity; therefore, all of the earnings and expenses of the business are included on the owner's individual tax return.
A business's profit may be impacted when creating a corporation because the business becomes its own separate entity and its tax return must be filed separately from the owners'.
A key advantage of an LLC is the ability to choose how the income of the business is reported.
Due to that fact that the IRS does not consider an LLC a legal entity when it comes to taxes, owners may opt to file as a corporation or a sole proprietorship.
Personal Liability Protection for a Sole Proprietorship
The biggest detriment of managing a sole proprietorship is the absence of a shield protecting the owner from the business's debts. If a sole proprietorship owes debts from the operation of the business, the owner's personal assets are at risk of being confiscated.
The main attraction of forming an LLC or corporation is the personal liability feature that protects the members from the debts of the business.
Benefits of an LLC
The process of forming an LLC is simple and inexpensive.
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