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3 Things to Avoid When Choosing Your Business Entity

Published By Janet Gershen-Siegel at October 11th, 2017

Do You Know What to Avoid When Choosing Your Business Entity?

Business entities come in several flavors but they are not all the same. You cannot just close your eyes and point. Instead, you need to take several factors into consideration when selecting a business entity. You want to get this right. So this is what to avoid when choosing your business entity.

Things to Avoid When Choosing Your Business Entity: 1. Tax Issues

We all have to deal with the Internal Revenue Service. And your small business is no exception. Depending upon your business entity, you could personally be responsible for taxes. Or you might even find yourself double taxed.

Here are some specifics:

Sole Proprietorships

Sole proprietorships – since the single owner and the sole proprietorship are one and the same; the owner pays taxes on the sole proprietorship’s profits.

Partnerships

Partnerships – A partnership does not have to pay income tax. Rather, the business will pass through its profits or losses straight to its partners. Then the partners will include their respective share of the partnership’s income or loss on their personal tax returns.

Corporations

Corporations – Corporations have to pay state and federal taxes, and they sometimes also have to pay local taxes. This will include paying income taxes on profits (the opposite of partnerships and sole proprietorships have to do). A corporation can end up paying taxes twice: first when it makes a profit, and the second time when dividends go to the shareholders.

S Corporations

S Corporations – an S corporation is often a good choice for tax savings purposes. The members of an LLC have to pay an employment tax on the entire net income of the business. However, only the wages of any S corporation shareholder who is also an employee are subject to employment tax. Any remaining income is payment to the owner as a distribution. Distributions are taxed at a lower rate, if at all.

Limited Liability Corporations

LLCs – an LLC is not a separate entity according to the IRS, so it isn’t taxed. Instead, the members pay individual taxes.

Things to Avoid When Choosing Your Business Entity: 2. Legal Liability

If your employee gets into a car accident while on the job, does your company have to pay part of any settlement or verdict?

Do you have to pay, out of your own pocket? What if your employee commits sexual harassment and your company is the subject of a lawsuit?

Or what if your employee commits a felony, like homicide, while on the job? What if your employee breaks federal law, such as mail fraud?

The different business entities expose owners to differing degrees of legal liability. Let’s get a look at the details:

Sole Proprietorships

Sole proprietorships – there are no limits at all to personal liability. If the sole proprietorship did it, then so did its one owner. You are responsible for all debts and obligations, and that includes any risks from actions of employees. Essentially, you, the sole owner, equal the company.

Partnerships

Partnerships – Partnership owners retain full, shared liability. Therefore, partners are not only liable for their own actions. They are also liable for any business debts and decisions made by the other partners. Furthermore, all of the partners’ personal assets can be seized to satisfy the partnership’s debt. If you end up in a bad business partnership, and your partner doesn’t pay the rent and instead gambles away the money at the tables in Vegas, you might have to foot the bill with your own money to cover the rent.

Corporations

Corporations – Within a corporation, the shareholders’ personal assets have protection. Shareholders can usually just be held accountable for their investment in the stock of the company. However, if your employee commits fraud or a felony under your direction, the corporate ‘veil’ can be ‘pierced’, and your personal assets can be on the line. The obvious remedy against this is: don’t tell your employees to commit fraud or felonies.

S Corporations

S Corporations – An S corporation shareholder’s personal assets, just like their personal bank accounts, cannot be seized for the purpose of satisfying any business liabilities, such as verdicts against the company.

Limited Liability Corporations

LLCs – LLC members have protection from personal liability for the business decisions or actions of the LLC. Therefore if the LLC incurs debt or becomes the subject of a lawsuit, the members’ personal assets are usually exempt. But not always, hence the term ‘’limited liability’.

Things to Avoid When Choosing Your Business Entity: 3. Costs and Shares

These are really up to you when it comes to selecting a business entity. No matter which business entity you choose, know the facts going into it. Here are some details:

Sole Proprietorships

Sole proprietorships –you are the company. If it makes money, so do you. Of course you need to pay rents, salaries for any employees you might have, taxes, etc. But your share is 100%.

Partnerships

Partnerships –partner shares vary, and they should be clearly spelled out in the partnership agreement. You do not have to split everything evenly, particularly if one partner wants to only be on the sidelines. In that instance, you might want a limited partnership, where one (or more) partner steps back and has limited liability, but also limited decision-making capabilities.

Corporations

Corporations – a corporation is run by its board of directors. They are usually (although not always) also the owners. Ownership stakes are defined by what percentage of stock everyone owns. If one person has a controlling interest (over 50% of the stock), then their decisions will generally overrule everyone else’s.

If the shareholders have smaller stakes in the corporation, then sometimes shareholders will band together. They do so in order to influence decisions or even kick board members out. Profits are generally distributed per the share percentages, although board members can take a salary.

Business Funding Credit Suite-Avoid When Choosing Your Business Entity

Learn more here and get started toward building business credit attached to your company’s EIN and not your SSN.

S Corporations

S Corporations –In this species of corporation, a shareholder working for the company must pay him or herself reasonable compensation. The shareholder has to get fair market value, or the IRS may reclassify any additional corporate earnings as wages.

Limited Liability Corporations

LLCs – An LLC is another type of corporation and the only real difference is liability rather than shares and costs, so it works like other corporations.

Things to Avoid When Choosing Your Business Entity: Building Business Credit

While technically you could build business credit with any entity, corporations or LLCs are generally best.

Business credit is credit in a company’s name. It doesn’t link to an owner’s individual credit, not even when the owner is a sole proprietor and the sole employee of the small business.

As such, a business owner’s business and personal credit scores can be very different.

Things to Avoid When Choosing Your Business Entity: The Advantages

Since small business credit is separate from consumer, it helps to safeguard an entrepreneur’s personal assets, in the event of a lawsuit or business insolvency.

Also, with two distinct credit scores, a small business owner can get two different cards from the same vendor. This effectively doubles buying power.

Another benefit is that even startup ventures can do this. Heading to a bank for a business loan can be a recipe for disappointment. But building company credit, when done properly, is a plan for success.

Consumer credit scores depend upon payments but also other components like credit utilization percentages.

But for small business credit, the scores truly merely hinge on if a business pays its debts on time.

Things to Avoid When Choosing Your Business Entity: The Process

Establishing small business credit is a process, and it does not happen automatically. A small business must actively work to build company credit.

However, it can be done readily and quickly, and it is much speedier than building individual credit scores.

Merchants are a big component of this process.

Performing the steps out of order will lead to repetitive denials. No one can start at the top with company credit. For instance, you can’t start with retail or cash credit from your bank. If you do, you’ll get a rejection 100% of the time.

Things to Avoid When Choosing Your Business Entity: Company Fundability

A company must be fundable to lenders and merchants.

Due to this fact, a business will need a professional-looking web site and e-mail address. And it needs to have website hosting from a supplier like GoDaddy.

Additionally, company phone and fax numbers must have a listing on 411.com.

Additionally, the company telephone number should be toll-free (800 exchange or the equivalent).

A company will also need a bank account devoted purely to it, and it needs to have every one of the licenses necessary for operation.

Licenses

These licenses all must be in the precise, appropriate name of the small business. And they need to have the same company address and telephone numbers.

So note, that this means not just state licenses, but potentially also city licenses.

Business Funding Credit Suite-Avoid When Choosing Your Business Entity

Learn more here and get started toward building business credit attached to your company’s EIN and not your SSN.

Things to Avoid When Choosing Your Business Entity: Dealing with the Internal Revenue Service

Visit the Internal Revenue Service website and get an EIN for the business. They’re free of charge. Choose a business entity like corporation, LLC, etc.

A business can start off as a sole proprietor. But they will most likely want to switch to a kind of corporation or an LLC.

Sole Proprietors Take Note

If you operate a small business as a sole proprietor, then at least be sure to file for a DBA. This is ‘doing business as’ status.

If you do not, then your personal name is the same as the business name. Hence, you can end up being directly accountable for all small business debts.

Also, per the Internal Revenue Service, by having this arrangement there is a 1 in 7 probability of an IRS audit. There is a 1 in 50 possibility for corporations! Avoid confusion and drastically reduce the odds of an IRS audit simultaneously.

Starting Off the Business Credit Reporting Process

Start at the D&B web site and get a cost-free D-U-N-S number. A D-U-N-S number is how D&B gets a company into their system, to generate a PAYDEX score. If there is no D-U-N-S number, then there is no record and no PAYDEX score.

Once in D&B’s system, search Equifax and Experian’s sites for the business. You can do this at www.creditsuite.com/reports. If there is a record with them, check it for accuracy and completeness. If there are no records with them, go to the next step in the process.

In this way, Experian and Equifax will have activity to report on.

Vendor Credit Tier

First you should build trade lines that report. This is also known as the vendor credit tier. Then you’ll have an established credit profile, and you’ll get a business credit score.

And with an established business credit profile and score you can start to obtain credit in the retail and cash credit tiers.

These sorts of accounts have the tendency to be for the things bought all the time, like marketing materials, shipping boxes, outdoor work wear, ink and toner, and office furniture.

But first off, what is trade credit? These trade lines are credit issuers who will give you preliminary credit when you have none now. Terms are often Net 30, rather than revolving.

Therefore, if you get approval for $1,000 in vendor credit and use all of it, you need to pay that money back in a set term, like within 30 days on a Net 30 account.

Details

Net 30 accounts need to be paid in full within 30 days. 60 accounts need to be paid in full within 60 days. Unlike with revolving accounts, you have a set time when you have to pay back what you borrowed or the credit you made use of.

To begin your business credit profile the right way, you need to get approval for vendor accounts that report to the business credit reporting bureaus. Once that’s done, you can then use the credit.

Then pay back what you used, and the account is on report to Dun & Bradstreet, Experian, or Equifax.

Vendor Credit Tier – It Helps

Not every vendor can help in the same way true starter credit can. These are vendors that will grant an approval with a minimum of effort. You also need them to be reporting to one or more of the big three CRAs: Dun & Bradstreet, Equifax, and Experian.

You want 5 to 8 of these to move onto the next step, which is the retail credit tier. But you may need to apply more than one time to these vendors. So, this is to demonstrate you are dependable and will pay on time.

Retail Credit Tier

Once there are 5 to 8 or more vendor trade accounts reporting to at least one of the CRAs, then move to the retail credit tier. These are businesses like Office Depot and Staples.

Just use your Social Security Number and date of birth on these applications for verification purposes. For credit checks and guarantees, use the business’s EIN on these credit applications.

One good example is Lowe’s. They report to D&B, Equifax and Business Experian. They want to see a D-U-N-S and a PAYDEX score of 78 or more.

Fleet Credit Tier

Are there 8 to 10 accounts reporting? Then move onto the fleet credit tier. These are companies such as BP and Conoco. Use this credit to buy fuel, and to repair, and take care of vehicles. Just use your Social Security Number and date of birth on these applications for verification purposes. For credit checks and guarantees, make sure to apply using the small business’s EIN.

One such example is Shell. They report to D&B and Business Experian. They need to see a PAYDEX Score of 78 or better and a 411 company telephone listing.

Shell might claim they want a specific amount of time in business or revenue. But if you already have enough vendor accounts, that won’t be necessary. And you can still get an approval.

Cash Credit Tier

Have you been sensibly handling the credit you’ve gotten up to this point? Then move onto the cash credit tier. These are companies like Visa and MasterCard. Just use your Social Security Number and date of birth on these applications for verification purposes. For credit checks and guarantees, use your EIN instead.

One example is the Fuelman MasterCard. They report to D&B and Equifax Business. They want to see a PAYDEX Score of 78 or more. And they also want you to have 10 trade lines reporting on your D&B report.

Plus, they want to see a $10,000 high credit limit reporting on your D&B report (other account reporting).

In addition, they want you to have an established company.

These are businesses like Walmart and Dell, and also Home Depot, BP, and Racetrac. These are normally MasterCard credit cards. If you have 14 trade accounts reporting, then these are attainable.

Things to Avoid When Choosing Your Business Entity: Monitor Your Business Credit

Know what is happening with your credit. Make certain it is being reported and fix any inaccuracies ASAP. Get in the habit of checking credit reports and digging into the specifics, and not just the scores.

We can help you monitor business credit at Experian and D&B for only $24/month. See: www.creditsuite.com/monitoring.

Update Your Data

Update the details if there are errors or the info is incomplete.

Things to Avoid When Choosing Your Business Entity: Fix Your Business Credit

So, what’s all this monitoring for? It’s to contest any inaccuracies in your records. Mistakes in your credit report(s) can be taken care of. But the CRAs typically want you to dispute in a particular way.

Disputes

Disputing credit report inaccuracies normally means you send a paper letter with copies of any evidence of payment with it. These are documents like receipts and cancelled checks. Never send the original copies. Always send copies and retain the originals.

Fixing credit report mistakes also means you precisely detail any charges you dispute. Make your dispute letter as understandable as possible. Be specific about the issues with your report. Use certified mail so that you will have proof that you mailed in your dispute.

Things to Avoid When Choosing Your Business Entity: A Word about Building Business Credit

Always use credit smartly! Never borrow more than what you can pay back. Keep an eye on balances and deadlines for payments. Paying off in a timely manner and fully will do more to increase business credit scores than virtually anything else.

Establishing small business credit pays off. Great business credit scores help a small business get loans. Your loan provider knows the business can pay its financial obligations. They recognize the company is bona fide.

The small business’s EIN links to high scores and credit issuers won’t feel the need to require a personal guarantee.

Business credit is an asset which can help your business for many years to come.

Business Funding Credit Suite-Avoid When Choosing Your Business Entity

Learn more here and get started toward building business credit attached to your company’s EIN and not your SSN.

Things to Avoid When Choosing Your Business Entity: Takeaways

The bottom line, quite literally, is that you need to decide what is best for you. Want lower taxes? Then you probably want an S-Corporation or a partnership. Want to shield yourself from liability? Then you probably want some form of corporation.

Want to have control? Then either keep a controlling interest in a corporation or partnership. Or you could stay a sole proprietorship. Want more profits? Then it can be tossup. This depends on how successful your company is.

Choose wisely.

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