As your business grows, it's essential to ensure that your business structure continues to align with your goals. Whether you're adding new products, changing ownership, or simply evolving, the structure of your business can have significant tax and operational implications. Let's explore some of the most common business structures—Hobby, Sole Proprietorship, LLC, S-Corporation, and C-Corporation—and what they mean for your company.
Hobby vs. Business: When It's More Than Just a Hobby
If your activity is primarily for pleasure and not for profit, it's classified as a hobby. While you may still earn income from a hobby, the IRS treats it differently than a business. You can't deduct expenses exceeding your hobby income; any earnings must be reported as income on your tax return. If your business is growing or you're investing significant time and money, it might be time to consider formalizing your structure.
Pros:
- No formal business structure or registration required
- Simple tax reporting
Cons:
- Limited tax deductions
- Higher personal liability for any debts or legal issues
Sole Proprietorship: The Simplest Business Structure
A Sole Proprietorship is the most straightforward business structure and is ideal for single-owner businesses. There's no legal separation between the owner and the company, meaning the owner is personally liable for all debts and obligations. Income and expenses are reported on your personal tax return, making tax filing relatively simple.
Pros:
- Easy to set up and operate
- Minimal paperwork and low startup costs
- Full control over business decisions
Cons:
- Unlimited personal liability for business debts
- Limited ability to raise capital
- Business income is subject to self-employment tax
LLC: Flexibility and Protection
An LLC offers a middle ground between a Sole Proprietorship and a Corporation. It provides the liability protection of a corporation while allowing the profits and losses to pass through to the owners' personal tax returns. This structure is popular for small businesses because it combines flexibility with liability protection.
Pros:
- Limited liability for owners
- Flexible management structure
- Pass-through taxation (avoiding double taxation)
Cons:
- More complex and expensive to set up than a Sole Proprietorship
- Self-employment taxes may still apply
- Varies by state, which can affect compliance costs
S-Corporation: Tax Advantages for Small Businesses
An S-corporation is a particular type of corporation designed to avoid the double taxation that affects C-corporations. It allows income, deductions, and tax credits to pass through to shareholders, who report them on their personal tax returns. To qualify, the business must meet specific IRS requirements, including having no more than 100 shareholders.
Pros:
- Avoids double taxation
- Limited liability protection
- Can save on self-employment taxes
Cons:
- Strict IRS requirements and regulations
- More complex to set up and maintain
- Must pay reasonable salaries to shareholders who work in the business
C-Corporation: A Structure for Larger Businesses
A C-Corporation is a separate legal entity from its owners, providing the strongest protection against personal liability. This structure is typically used by larger businesses or those seeking to raise significant capital. C-Corporations are subject to double taxation—once at the corporate level and again when dividends are paid to shareholders.
Pros:
- Limited liability for owners
- Easier to raise capital through the sale of stock
- Perpetual existence, even if ownership changes
Cons:
- Double taxation (corporate and personal levels)
- Complex setup and ongoing administrative requirements
- More regulatory oversight and compliance obligations
Why Your Business Structure Matters
Choosing the right business structure is critical for legal and operational reasons as well as tax efficiency. The structure you choose can affect everything from how you're taxed to how much personal liability you take on. As your business evolves, revisiting your structure can help ensure it continues to serve your needs and supports your growth.
That said, determining the best structure isn't always straightforward. That's where Myrick CPA can help. We specialize in guiding small businesses through these decisions, ensuring you choose the structure that aligns with your goals and offers the best tax advantages.
Do you need some assistance to determine the proper structure for your business? Contact Myrick CPA to schedule a consultation, and let us help you make the best decision for your company's future.