1. What does your business structure type affect?
- Your ability to sell on various platforms—especially on Amazon if you live in a non-Amazon approved country
- How you set up your bank account
- The protection level of your personal assets
- How you pay taxes and what kind of taxes you are obligated to pay
- Your ability to raise capital and gain investments
- Your ability to sell your business after it grows huge
2. What are the main business structure types?
Sole proprietorship is the default business type when you start a business as a single person.
A sole proprietor owns an unincorporated company by themself.
Many sole proprietors don’t even know they are sole proprietors. They call themselves, “freelancers,” or, “self-employed.” But if they are not partnering with anyone and never set up a business entity, they are sole proprietors.
For example, if you decide to sell lemonade on the sidewalk without filing with the government, you are a sole proprietor.
You usually don't have to file with the government to be a sole proprietor. Legally, you and the business are the same entity under this business structure.
General partnership is the default business type when two or more professionals start a business together.
A partnership business structure type is when multiple sole proprietors get together to run a company.
For example, if you and a buddy decide to sell lemonade on the sidewalk, the two of you together would be considered in a partnership.
In most states, you don't have to file to become a partnership.
Limited partnership is when one or more of the partners/owners in a company invests assets into the business but does not manage any business operations.
This is similar to a partnership except that one or more person's sole role is to provide resources or capital for the company. The business person(s) providing capital is known as a limited partner, and the business person(s) running operations is a general partner. Limited partners are sometimes called “silent partners.”
For example, if you provide you buddy $200 to open a lemonade stand, and your buddy runs the lemonade stand by themself, then you are a limited partner, and your buddy is a general partner.
You must file with the government for limited partnership.
Limited liability company (LLC) status provides legal protection with the state by making a company its own entity separate from its owners.
LLC status does not have any effect on taxes. All LLC status does is provide legal protection.
One person can open an LLC. Two or more people can also open an LLC. Owners of LLCs are called "members."
You register an LLC with the US state, not the federal US government.
For example, if you and/or a buddy open a lemonade stand and register it as an LLC, your taxes do not change. However, the state will recognize your company as having its own identity separate from you.
C corporations have their own legal identity and are taxed separately from their owners.
The C corporation business type is designed for large businesses that need to raise funds.
For example, if you and several others establish a chain of lemonade fast food locations, you may want to consider registering as a C corporation.
Owners of corporations are called "shareholders."
To incorporate means to set up a business so that it carries its own identity separate from the owners of the organization. It is a separate legal entity under state and federal law. Corporations pay their own taxes, can initiate litigation, and be sued independently from their shareholders.
In the UK, corporations are called limited companies. In Canada, they are called incorporations.
Corporations typically receive strategic direction from a board of directors and have officers (CEO, CXO, etc.) to run day-to-day tasks.
An LLC can elect (form 8832) to be treated as a corporation.
S corporation is a special tax designation registered with the federal government. Technically, S corporation is not a business type.
Your business must first be registered as an LLC or C corporation in order to apply for S corporation status.
The advantage of being in an S corporation is that you can save money on taxes depending on your situation.
When you are either an LLC or a C corporation being taxed as an S corporation, then the company will still be treated as a separate entity from you, the company owner. Therefore, S corporation status to not affect your liability.
3. How does your business structure status affect your liability?
To be liable for something means to be legally responsible.
Either you or your business (generally not both) can be held liable for damages in a court of law depending on the business structure type you pick.
You can be sued by anyone for any reason. Not anyone can win a case against you or have a viable reason for suing you, but you or your business can be sued nonetheless.
For example, let’s say you unintentionally use a product image that belongs to someone else. You downloaded the image from a “free stock photo” website, but the photographer sues you anyway because they never gave the website permission to distribute the photo. You could be held liable and have to pay compensation including legal fees.
If you don't have liability protection, you are liable.
In this case, anything you own is fair game. You could lose your house, your car, your 401K, your dog—anything you own is at risk.
If you have liability protection, only your business is liable—not you.
In this case, what your business owns is at stake. You could lose your inventory, profits, and business assets, but what you personally own is not at risk.
Sole proprietorship and general partnership carry the most legal risk.
If you become a sole proprietor or general partner, your personal assets have zero liability protection from lawsuits.
But, liability protection usually isn't relevant unless you are:
1. Selling high risk products (baby products, supplements)
-OR-
2. Making a ton of money
If neither of these two things are true for you, then your chances of someone suing you at this stage are almost zero.
You can easily upgrade to a company structure with better liability protection, like an LLC, later on.
Additionally, until you and your company have a lot of money, a smart lawyer won’t waste time on you.
LLCs, C corporations, S corporations, and limited partnerships carry the least legal risk.
If you are a C corp, S corp, LLC, or limited partner, you have liability protection. Legally, your business is treated as a separate entity from you. Therefore, your business is liable in case of a lawsuit, but no one can seize your personal belongings and assets.
This is why a limited liability company is called “limited.” There is a limitation on who is liable (just the business).
4. How does your business structure type affect your taxes?
Every business pays taxes at some level.
Unless you leverage debt and assets to lower your income to net zero, similar to what Robert Kiyosaki does, there are no legal loopholes to avoid paying taxes. Don't risk fines or jail time!
However, you have some control over how much tax you pay based on the business structure you choose.
Depending on your business structure, you will get paid via compensation and/or dividends.
Compensation includes both wages and bonuses. Wages are regular paychecks based on hourly or salaried pay. Bonuses are one-time or periodic payouts based on work—not ownership in the company.
For example, if you make $5,000 per week regardless of how many hours you work, that is a salaried wage. If you make $15 per hour you work, that is an hourly wage. Salaried wages and hourly wages are taxed the same way.
If you receive $500 as a one time payout each Christmas from your employer, that is a bonus. If you work in sales and get $10 pay for every $100 of revenue you personally bring to the company, that is also a bonus because your payout is based on your work performance.
Dividends are payouts based on your investments/ownership in the company—not based on how much you work.
For example, if you make $5 for every $100 the company makes, that is a dividend. Dividends are also called "distributions" depending on the company type.
There are 4 kinds of taxes on compensation and dividends you need to understand.
Income tax is levied by the US federal government (and sometimes US states) on your compensation and dividends.
In other words, you must pay income tax on every dollar you make. Income tax is owed once a year to the US federal government. Some states, like California, also collect income tax. Some states, like Texas, do not collect income tax.
Income tax is levied against your income, not your company’s income.
This is why if you are an LLC, general partner, sole proprietorship, or are taxed as an S corporation, all your income is considered “pass-thru” income. With pass-thru income, there is no distinction between your company's profits and your income. The two equal one another.
Pass through income is taxed at the individual rate instead of the corporate rate.
The percentage of your compensation and dividends that you pay in income tax typically scales up with how much you make.
Social Security tax is levied on your compensation.
The government collects 12.4% of your wages for Social Security tax. When you are employed, your employer pays half of the social security tax (6.2%). You will pay the other 6.2% when you are employed. If you are your own employer, you must pay the full 12.4% yourself.
However, there is a cap on how much Social Security tax you have to pay. In 2021, Social Security tax is charged up to a $142,800 compensation cap. This cap fluctuates each year. The cap means if you make $150,000 as an employee in 2021, you will only be taxed the 6.2% on $142,800 of your wages.
This tax funds the US Social Security program, which pays for the retirement, disability, and survivorship benefits received by millions of Americans each year.
Medicare tax is levied on your compensation.
The government collects 2.9% of your wages for Medicare tax. When you are employed, your employer pays half of the Medicare tax (1.45%). You will pay the other 1.45%. If you are your own employer, you must pay the full 2.9% yourself.
There is no cap on Medicare tax. For example, if you make $150,000 as an employee in 2021, you will be taxed 1.45% on $150,000 of your wages—even though the Social Security tax cap is $142,800.
Medicare tax + Social Security tax together are known as FICA (Federal Insurance Contributions Act) tax.
To an employer, this is called payroll tax. To a business-owner, this is called self-employment tax.
Corporate tax is levied on an incorporated business's profits.
The federal government and most US states will levy corporate taxes on incorporated businesses separately from the owners.
Corporate tax is levied on the profits of a corporation. Unlike income tax, corporate tax is not levied on the earnings of an employee or business owner.
In the US, corporate tax is a flat rate. In other words, there is no corporate tax bracket.
Corporate tax is usually lower than income tax for individuals making more than $100,000 a year.
Sole proprietors and general partners must pay income tax and FICA tax on all of their earnings.
If you are a sole proprietorship or general partner, you pay:
- Income tax (percentages vary based on your income amount).
- FICA tax (15.3% self employment tax).
Sole proprietors do not pay:
- Corporate tax. All profits are considered personal income.
If you are a partnership (more than one member), the profits are split among the members. Each member must pay income and FICA tax on their earnings.
For example, if your sole proprietorship net income is $100,000, then you pay 24% of the $100,000 for income tax ($24,000) and 15.3% in FICA taxes ($15,300), totalling to $39,300 in taxes.*
Visit the IRS site to see more
* Note: this is an example for demo purposes only. Consult an accountant or tax lawyer for details.
Limited partners must pay income tax on their dividends. They do not pay FICA because limited partners cannot earn a salary.
If you are a limited partner, you pay:
- Income tax (percentages vary based on your income amount).
Limited partners do not pay:
- FICA tax (15.3% self employment tax).
- Corporate tax. All profits are considered personal income.
Only partners who work on the business (general partners) earn a salaried income.
C corporations pay corporate tax. Additionally, officers/employees must pay FICA and income tax on compensation. Shareholders pay income tax on distributions.
If you are a shareholder of a C corporation (owner) and do tasks on behalf of the company (are your own employee), you pay:
- FICA tax on compensation.
- Income tax on compensation.
- Income tax on distributions.
Shareholders do not pay:
- FICA tax on distributions.
Your corporation pays:
- Corporate tax on profits.
C corporations are the only company structure (of the six we have considered) that pay taxes as a company. They pay taxes on company profits.
First, company profits are taxed at the corporate tax rate.
Second, those same profits are taxed again at a personal income tax rate when they are distributed to officers, other employees, and shareholders as compensation or distributions.
This creates double taxation.
For example, Corporation "Tax Us Please" in the US makes $100 in profit. It pays $21 in corporate taxes.
The remaining $79 is paid out to its two shareholders, each receiving $39.50 as compensation.
If the shareholders are in the 25% income tax bracket, each pays $9.88 in personal income tax plus 15.3% FICA tax ($5.97 each).
In other words, of the $100 profit made by the company, a total of $52.70 is paid out in taxes*.
* Note: this is an example for demo purposes only. Consult an accountant or tax lawyer for details.
C Corporations may pay shareholders with dividends and/or compensation (wages and bonuses). C Corporations are not required to pay compensation to their shareholders. C corporations are required to pay compensation to their officers/employees. Both shareholders and officers pay income tax on the money they receive.
If the C corporation chooses to pay its shareholders dividends instead of salaries, then the shareholders do not pay FICA tax on those dividends. This benefits the shareholders.
If the C corporation chooses to pay its shareholders compensation instead of dividends, the shareholders have to pay the 15.3% FICA tax.
However, the corporation may use the compensation payments as tax deductions against their company profits. This benefits the corporation.
You may be thinking: Can a C Corporation pay dividends instead of compensation to its officers running day-to-day operations (who happen to be shareholders)?
Theoretically this could save the officers money because there is no FICA tax on dividends.
This is illegal, and the company could get in trouble with the IRS.
The IRS says, “When corporate officers perform a service for the corporation and receive or are entitled to payments, those payments are considered wages...The fact that an officer is also a shareholder does not change this requirement. Such payments to the corporate officer are treated as wages.”
In other words, C Corporations must pay compensation to the people running the company—even if the officers are also shareholders.
If C corporations try to pay officer-shareholders exclusively dividends, the IRS is going to see that as compensation. Those officers running the company are required to pay FICA tax on their compensation.
C corporations are not required to pay salaries like S corps are. However, if no one is hired, then the IRS can levy fines and consider a dividend distribution as a salary and require FICA taxes, since someone has to be doing the work of running the business.
Since you have to pay officer-shareholders some compensation, and compensation is taxed harder than dividends, can you lower your compensation and increase your dividend payout to reduce your tax liability?
Not exactly. The compensation must be "reasonable" for the role in the company, region you live in, and consistent with the industry you work in.
For example, if you live in San Francisco (one of the most expensive cities in the world), $30,000 would be an unreasonably low salary for a CEO in just about any industry. But $30,000 might be a reasonable salary for a low-level employee living in rural Mississippi in the textiles industry.
However, a salary for an officer can be lower for companies that are not yet profitable and are still in the startup stage.
S corporations do not pay corporate taxes. Officers/employees must pay FICA and income tax on compensation. Shareholders pay income tax on distributions.
If you are a shareholder in a company with S corporation tax status and do tasks on behalf of the company (are your own employee), you pay:
- FICA tax on compensation.
- Income tax on compensation.
- Income tax on distributions.
Shareholders do not pay:
- FICA tax on distributions.
Your corporation does not pay:
- Corporate tax on profits. All profits are considered personal income.
There is no double tax.
After compensation is paid, the remaining company profits are passed through to shareholders as distributions which are taxed as personal income. You can save money on FICA tax if your salary from an S Corporation is lower than the profits of your company.
For example, let's say your company makes $100,000 total profit in a year, and you are the sole owner.
You pay yourself a salary of $50,000.
You will pay income tax and self employment tax on your salary of $50,000.
The remaining $50,000 is considered a distribution. You pay income tax on this remaining $50,000 but not FICA tax.
You save $7,650 in taxes (15.3% of $50,000).
This is how being taxed as an S corporation lowers your tax liability if done correctly. Keep in mind that your salary must be "reasonable" according to the IRS.
It may make sense for you to file for S corporation status if:
- Your salary from your S corp is lower than your profits. Otherwise you are paying the same amount of self employment tax.
- Your business income is higher than the salary you need. Otherwise, you won’t save any money.
Visit the IRS website for more info.
5. What paperwork do you need to file for each company type?
There is usually no setting up or paperwork required for a sole proprietorship.
Just start doing business. The IRS will automatically use your Social Security number (SSN) as your Tax Identification Number (TIN).
Alternatively, you may get an Employer Identification Number (EIN) to use as your TIN.
As a sole proprietorship, you need an EIN if you:
- Hire employees.
- Have a Keogh or Solo 401(k) retirement plan.
- Buy or inherit an existing business that you operate as a sole proprietorship.
- Incorporate or form a partnership or limited liability company.
- File for bankruptcy.
File Form SS-4 on the IRS website to obtain an Employer Identification Number (EIN). This is free to do.
In most cases, it costs $0 to set up a sole proprietorship.
You may need to apply for permits or licenses and other certificates specific to your industry.
As a general rule, there is no maintenance needed for a sole proprietorship, but always double check with your state.
There is usually minimal paperwork for setting up a general partnership.
When you establish a general partnership, write up an operating agreement.
Operating agreements set terms for profit share expectations between you and your partner(s), to protect you in case of a disagreement, what to do if someone decides to leave, or if there is a company loss and the partners need to know in advance on how to bear that loss.
General partnerships also need an EIN with the federal government. This is free to do. File Form SS-4 on the IRS website to obtain an Employer Identification Number (EIN).
In most cases, it costs $0 to set up a general partnership.
You may need to apply for permits or licenses and other certificates specific to your industry.
As a general rule, there is no maintenance needed for a general partnership, but always double check with your state.
It requires moderate paperwork to set up a limited partnership.
In order to establish a limited partnership, you will need to:
- Register with the state.
- Pay a fee to the state.
- File Form SS-4 on the IRS website to obtain an Employer Identification Number (EIN).
- Create an operating agreement. This explains how you and any relevant partners will conduct business as well as expectations.
It will cost $132 on average to file as a limited partnership.
As a general rule, there is no maintenance needed for a limited partnership, but always double check with your state.
It requires moderate paperwork to set up a limited liability company.
In order to establish your company as an LLC, you will need to:
- Choose your company’s legal name.
- File with the Secretary of State (or other relevant entity depending on your state).
- Pay a fee to the state.
- File the Articles of Organization. This is a simple document stating your purpose and is necessary to establish the existence of your LLC in the state.
- Create an operating agreement. This explains how you and any relevant partners will conduct business as well as expectations.
- File Form SS-4 on the IRS website to obtain an Employer Identification Number (EIN) unless you are a single member LLC.
You may need to apply for permits, licenses and other certificates specific to your industry.
It will cost $132 on average to file as a LLC.
There is generally no ongoing paperwork required for LLCs.
Some states charge an annual franchise tax for LLCs when you reach a certain amount of revenue. For example, in Texas, once your profits reach a number between 1 and 2 million dollars in a year, you owe a franchise tax.
Corporations require the most paperwork and have the most bureaucratic complexity.
To establish a C corporation, you will need to:
- Choose your company’s legal name.
- File with the Secretary of State (or other relevant entity depending on your state).
- Pay a fee to the state ($50-$800 to file depending on complexity).
- File the Articles of Incorporation. This is a simple document stating your purpose and is necessary to establish the existence of your C corporation in the state.
- Create an operating agreement. This explains how you and any relevant partners will conduct business as well as expectations.
- File Form SS-4 on the IRS website to obtain an Employer Identification Number (EIN).
- Appoint a board of directors. The board of directors is charged with overseeing the overall operations of the business enterprise. The chairman leads the meetings and the secretary takes minutes.
- The board of directors then appoint officers who are charged with running the business day-to-day. Officers typically include your executives such as CEO, president, COO, CFO, etc.
You may need to apply for permits, licenses and other certificates specific to your industry.
There is ongoing paperwork required for C corporations.
An S corporation is not a company type but a tax designation. An LLC or C corporation can file with the IRS to be taxed as an S corporation, but they still remain an LLC or C corporation. Therefore, maintenance for an S corporation is irrelevant since it depends on the original company type.
If you live outside the United States:
You can open an LLC in the US and you do not have to travel to the US to do this.
If you live in an Amazon-approved country, you can also open a company in your own country.
We show you how to do all that and more in our Amazon FBA Mastery membership. It's everything you could ever need to know, and then some, about starting, building, and running a successful online store. Apply to work with our coaches today!
