Did You Know that Choosing the Right Entity Can Save You?

Business entities can seem confusing. Choose the right business entity from the very beginning and save on taxes and company liability. Choosing the right entity can save you!

First, here are the more common business entities.

Choosing the Right Entity: Types of Business Entities

Sole Proprietorship

The SBA says a sole proprietorship is an unincorporated business owned and run by just one person. There is no difference between the owner and the business. That means you, the owner, get all of profits. But you are also responsible for all your business’s losses, debts, and liabilities.

Partnership

The SBA defines a partnership as a single business with two or more owners. Partnerships then divide into three types.

General Partnership

General partnerships assume the partners equally divide up all of the liability, profits, and management duties. But what if you want an unequal distribution? Then the percentages for each partner must be documented in the partnership agreement.

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

Limited Partnership

So this is also referred to a partnership with limited liability. These are more complex than general partnerships. A limited partnership means the partners have limited liability. But they also have limited input in management decisions. What a limit will be will depend on each partner’s investment percentage. Therefore, limited partnerships can be attractive to investors in short-term projects.

Joint Venture

Joint ventures work like a general partnership. But this is only a specific period of time or for a single project.

Partners in a joint venture can convert it to an ongoing partnership if they continue the venture. But they must file that way. So this is often with the IRS and the applicable Secretary of State.

Corporation

A corporation (also called a C corporation) exists as an independent legal entity. So its shareholders own it. So the corporation itself, and not the shareholders who own it, can be held legally liable. This is for actions and debts which the business incurs.

S Corporation (sometimes called a Subchapter S Corporation)

An S corporation works as a special type of corporation created by an IRS tax election. So this is the IRS’s Subchapter S designation. An eligible domestic corporations can avoid double taxes if they opt to be treated as S corporations. These double taxes are once to the corporation and again to the shareholders.

In an S Corporation, profits and losses can pass through to your personal tax return. The business itself is not subject to taxes. Only shareholders are subject to taxes. But any shareholder employees must pay themselves reasonable compensation. The shareholder has to get fair market value. Or else the Internal Revenue Service could reclassify additional corporate earnings as wages.

Limited Liability Company

A limited liability company exists as a type of hybrid legal structure. It has the limited liability features of a corporation. But it has the tax efficiencies and operational flexibility which partnerships enjoy. The owners of an LLC are called members. Depending on the state, members can be one person (that is, one owner. Or they can be two or more people, corporations, or even other LLCs.

Unlike corporate shareholders, LLCs are not subject to taxes as a separate business entity. Instead, all profits and losses pass through the business to each member of the LLC. Then LLC members report all the profits and losses on their personal federal tax returns. This is just like the owners of a partnership would.

There are two great reasons why it matters which business entity you choose. This is how the right entity can save you.

Choosing the Right Entity: Taxes

Here are the specifics:

Sole Proprietorships

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

Partnerships

Partnerships – The partnership does not pay income tax. Instead, the business passes its profits or losses to its partners. Then the partners include their respective share of partnership income or loss on their personal tax returns.

Corporations

Corporations – Corporations pay state and federal taxes. And they sometimes also pay local taxes. This includes income taxes on profits. A corporation can be subject to taxes two separate times. So this is first when a corporation makes a profit. And the second when dividends go to the shareholders.

S Corporations

S Corporations – an S corporation is often a smart choice for tax savings purposes. LLC members must pay an employment tax on the whole net income of the business. But only the wages of an S corporation shareholder who is an employee are subject to employment tax.

Any other income goes to the owner as a distribution. Distributions are subject to taxes at a lower rate, if at all.

Limited Liability Corporations

Limited Liability Corporations – an LLC is not a separate entity according to the IRS, so it does not pay taxes. Instead, the members are individually subject to taxes.

Legal Liability

Legal liability varies:

Choosing the Right Entity: Sole Proprietorships

Sole proprietorships – there are no limits on personal liability. If the sole proprietorship did it, then so did its owner. You are responsible for all debts and obligations. And these include any risks from the actions of employees.

Partnerships

Partnerships – Partnership owners have full, shared liability. Hence partners are liable for their own actions. And they are liable for any business debts and decisions made by the other partners. Furthermore, the partnership’s debts can be satisfied with all of the partners’ personal assets.

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

Corporations

Corporations – In a corporation, shareholders’ personal assets have protection. Shareholders are usually just held accountable for their investment in company stock.

S Corporations

S Corporations – An S corporation shareholder’s personal assets, like their personal bank accounts, cannot be used to satisfy any business liabilities. Hence these include verdicts against the company.

Limited Liability Corporations

LLC – LLC members are protected from personal liability for business decisions or actions of the LLC. If the LLC incurs debt or it is on the receiving end of a lawsuit, members’ personal assets are usually exempt. But not always. Hence the term ‘’limited liability’.

Choosing the Right Entity: Building Business Credit

Did you know you can build business credit with any business entity? But corporations are best. So even if you have a sole proprietorship, you should still be looking to incorporate.

This is credit in a business’s name. It doesn’t attach to an owner’s consumer credit, not even when the owner is a sole proprietor and the only employee of the business.

Therefore, a business owner’s business and consumer credit scores can be very different.

Choosing the Right Entity: The Advantages

Due to the fact that business credit is distinct from individual, it helps to safeguard a business owner’s personal assets, in case of a lawsuit or business bankruptcy.

Also, with two distinct credit scores, an entrepreneur can get two separate cards from the same vendor. This effectively doubles buying power.

Another advantage is that even startup companies can do this. Visiting a bank for a business loan can be a recipe for disappointment. But building business credit, when done right, is a plan for success.

Personal credit scores depend upon payments but also various other components like credit use percentages.

But for business credit, the scores really just depend on if a business pays its invoices on time.

Choosing the Right Entity: The Process

Growing company credit is a process, and it does not happen without effort. A business must actively work to establish business credit.

Nonetheless, it can be done easily and quickly, and it is much speedier than establishing individual credit scores.

Merchants are a big component of this process.

Accomplishing the steps out of order will result in repetitive rejections. Nobody can start at the top with business credit. For example, you can’t start with retail or cash credit from your bank. If you do, you’ll get a denial 100% of the time.

Choosing the Right Entity: Company Fundability

A business must be fundable to credit issuers and merchants.

Therefore, a business will need a professional-looking web site and e-mail address. And it needs to have site hosting bought from a company such as GoDaddy.

In addition, company phone and fax numbers should have a listing on ListYourself.net.

At the same time, the company phone number should be toll-free (800 exchange or similar).

A company will also need a bank account dedicated strictly to it, and it must have every one of the licenses essential for operating.

Licenses

These licenses all have to be in the identical, appropriate name of the company. And they need to have the same business address and phone numbers.

So keep in mind, that this means not just state licenses, but potentially also city licenses.

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

Choosing the Right Entity: Dealing with the IRS

Visit the IRS website and acquire an EIN for the business. Here’s where choosing the right business entity like corporation will save you.

A small business can begin as a sole proprietor. But they will more than likely want to switch to a kind of corporation or an LLC.

Sole Proprietors Take Note

If you run a company as a sole proprietor, then at the very 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 company name. Therefore, you can find yourself being personally responsible for all business financial obligations.

Also, per the IRS, by having this arrangement there is a 1 in 7 possibility of an IRS audit. There is a 1 in 50 possibility for corporations! Avoid confusion and considerably reduce the odds of an IRS audit at the same time.

Choosing the Right Entity: Beginning the Business Credit Reporting Process

Start at the D&B website and obtain a free D-U-N-S number. A D-U-N-S number is how D&B gets a business 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 websites for the business. You can do this at fastcs.wpengine.com/reports. If there is a record with them, check it for correctness and completeness. If there are no records with them, go to the next step in the process.

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

Vendor Credit Tier

First you ought to establish trade lines that report. This is also called 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 get credit in the retail and cash credit tiers.

These kinds of accounts tend 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 of all, what is trade credit? These trade lines are credit issuers who will give you starter credit when you have none now. Terms are usually Net 30, rather than revolving.

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

Details

Net 30 accounts must be paid in full within 30 days. 60 accounts have to be paid fully within 60 days. In comparison 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 like true starter credit can. These are merchants that will grant an approval with marginal effort. You also want 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 have to apply more than one time to these vendors. So, this is to confirm you are reliable and will pay promptly.

Retail Credit Tier

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

Only use your SSN 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 such example is Lowe’s. They report to D&B, Equifax and Business Experian. They need to see a D-U-N-S and a PAYDEX score of 78 or higher.

Fleet Credit Tier

Are there 8 to 10 accounts reporting? Then move onto the fleet credit tier. These are service providers such as BP and Conoco. Use this credit to purchase fuel, and to repair, and take care of vehicles. Only 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 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 more and a 411 business phone listing.

Shell may claim they want a particular amount of time in business or profits. 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 responsibly 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 SSN and date of birth on these applications for verification purposes. For credit checks and guarantees, use your EIN instead.

One such 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).

Additionally, they want you to have an established business.

These are service providers like Walmart and Dell, and also Home Depot, BP, and Racetrac. These are usually MasterCard credit cards. If you have 14 trade accounts reporting, then these are in reach.

Choosing the Right Entity: Monitor Your Business Credit

Know what is happening with your credit. Make sure it is being reported and attend to any mistakes ASAP. Get in the practice of taking a look at 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 90% less than it would cost you at the CRAs. See: fastcs.wpengine.com/monitoring.

Update Your Information

Update the details if there are inaccuracies or the details is incomplete.

Choosing the Right Entity: Fix Your Business Credit

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

Disputes

Disputing credit report mistakes usually means you send a paper letter with copies of any proof of payment with it. These are documents like receipts and cancelled checks. Never send the original copies. Always send copies and keep the originals.

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

Choosing the Right Entity: A Word about Building Business Credit

Always use credit sensibly! Never borrow more than what you can pay off. Track balances and deadlines for repayments. Paying off in a timely manner and completely will do more to increase business credit scores than just about anything else.

Building business credit pays. Great business credit scores help a business get loans. Your lender knows the business can pay its financial obligations. They understand the company is authentic.

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

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

Choosing the Right Entity: Takeaways

Which business entity should you go for?

It is your decision to make. Pay close attention to the tax burden and personal liability as they can affect you. So this is particularly if you have a business with known hazards, like carpentry or exterminating.

You might also want to consider how much control you want to have over your business. A sole proprietorship means you call all the shots. But it also means you are responsible for everything. That can be too much to handle. If it is, then consider one of the other common business entities for a small business.