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“This is your life.
You want to get it right.”– Mark Cuban on Starting a Business
Entrepreneur and Shark Tank host lays out 3 steps to follow when starting a business
A sole proprietorship doesn’t have a formal formation process other than getting a DBA (if you want one), business licenses (if needed), or permits (if your business needs them).
First, you should understand that an S corporation is not a business structure or separate legal entity like a corporation or LLC. Rather, it’s a tax classification that either an LLC or a corporation can apply for with the Internal Revenue Service (IRS) if it meets the criteria.
Over a sole proprietorship: In order to get S corporation status, you must first become an LLC or a corporation, both of which provide limited liability protection.
Over a C corporation: Electing S corporation status means avoiding double taxation.
Over an LLC: An LLC taxed as an S corporation may be able to lower what the owners pay for Social Security and Medicare taxes.
Legally, you and your sole proprietorship are considered the same entity. Someone who sues your business is also suing you. That means everything you own – your bank account, home, car, etc. – can be impacted by litigation.
A traditional LLC already has pass-through taxation, so the benefits of S-corp election for an LLC have to do with self-employment tax. This requires some explaining, but for certain LLCs, it could save a lot in taxes.
The members of a standard LLC are considered self-employed. They’re compensated by receiving their share of profits from the LLC, but they can’t be employed by the LLC. Being self-employed means paying self-employment taxes (Social Security and Medicare, which adds up to about 15.3%) on all profits they receive from the LLC. This is more than the taxes they’d pay when working for someone else because their employer would pay part of them.
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¹If your sole proprietorship has a “doing business as” (DBA) name (also known as a trade name, assumed name, or fictitious name depending on your state), you may not be able to continue using it when you form your LLC. DBA laws vary widely by state. If your state allows DBAs and LLCs to share the same name and your DBA is the same as an existing LLC’s name, you’ll need to find a new name for your LLC before you file your paperwork with the state. No state allows two LLCs to share the same name.