Creators, Stop Worrying About Entity Type Selection
If I see one more ad for a webinar about “Entity selection for young entrepreneurs,” I'm going to scream. Sometimes well-meaning, though usually hawking a service, these webinars sidestep the question of whether young entrepreneurs NEED a corporate entity at all and instead focus on which one they should choose (and then which of their services these young creators can pay for). Actually... instead of screaming, I’ll write a blog post about it!
But wait what do you mean by corporate entity?
An entity is ultimately responsible for every financial activity. An entity can be an individual (i.e. you or me) or not. An entity that is not an individual is usually a partnership (a group of individuals), a corporation, a trust, or a limited liability company (LLC).
What’s so good about corporate entities?
There are many reasons why people use corporate entities to contain their business operations, but most of them only matter when you
a) already have some money, or
b) are making a lot of it.
One big reason to have your business inside a corporate entity is to shield your personal assets. If you as an individual are responsible for your business, when people sue your business, they are suing you! If you own your home or have other valuable assets to protect, then housing your business in a corporation is a really good idea! But if you’re 25 and don’t really have any assets, then who cares?
Isn’t there a tax benefit?
Depending on many factors outside the scope of this post, there are often tax advantages to having a corporate entity. Some entity types can even “elect” to be taxed in a particular way, and then later change that election later when it suits different circumstances.
For example, a corporation or an LLC can elect to be taxed as a “subchapter S” corporation, which means the business itself doesn’t pay any federal income tax, instead the federal tax burden passes to the owners of the business.
But years later if there are more owners or more revenue to contend with, the corporation can elect again to be taxed instead as a “subchapter C” corporation, where corporate profits are taxed. Corporations can also be created to be not-for-profit and not taxed at all.
But do you know what a business needs for any of this tax stuff to matter? A significant amount of income.
So what’s the downside?
While there are DIY options for the hardcore, you’re likely going to need some kind of legal or paralegal service to set this up the corporate entity for you. That has a cost.
To get your business registered, there are state and possibly municipal filings to consider. If you think you can shirk this, I assure you they will find you eventually. They typically have annual or bi-annual filings (and fees).
If you opt for a corporation, in addition to the startup paperwork there are annual meeting and documentation requirements that someone needs to take care of. They are easy enough to do but rest assured someone will be willing to take your money to do it for you.
In many states including California, any for-profit entity has a tax burden (in California it's $800 per year minimum).
And what’s the alternative?
Any entity including an individual can get a fictitious business name (also known as a DBA, or Doing Business As, for example Joe Blough DBA The Magic Banana Factory). Registering the fictitious business name holds it for you at least in the county where it's registered and enables you to get a bank account in the name of the business. The underlying entity, including the tax rules and liability remain with the individual.
This kind of registration is much simpler and cheaper than any type of corporate entity and it’s mainly required to get a bank account in the business’s name. It certainly won’t help you with anything related to insurance.
You can also just be Joe Blough standing under a sign that says “Magic Banana Factory,” just make sure they are making out checks to Joe Blough!
So what now?
Answer these questions:
Do you have a lot of assets that you need to protect?
Does your business have a ton of income you need to mitigate tax for?
If you answered no to both, consider starting as an individual, maybe with a fictitious business name, because all that other stuff costs money and might accidentally create a tax burden and can be complicated to set up and maintain. Until you have profits, there is no tax burden.
What you should be spending time doing is perfecting your product, developing your vision and creating your brand. Administrative hoo-ha pales in comparison to all these things, not to mention the MOST important thing in a new business which is SALES.
Speaking of sales, if you answered yes to either of those questions and you still need help,
drop me a line at firstname.lastname@example.org