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Entity Selection
If you are thinking about starting a small business, one of your first decisions you must make is to determine your type of entity. Each option has their unique set of advantages and disadvantages.
We cover the three most common types of entities that we deal with:
- Sole Proprietorship
- Limited Liability
- S Corporation
Sole Proprietorship
Limited Liability Company
Limited Liability Company
The simplest option with little to no filing requirements or costs to get started, other than your annual tax return filing on Schedule C.
Limited Liability Company
Limited Liability Company
Limited Liability Company
This option is more formal, offers limited liability and greater credibility for your small business, but with additional costs and filings.
S Corporation
Limited Liability Company
S Corporation
This option is definitely the most complex with payroll and tax filing requirements, but this entity may offer the greatest tax savings.
Sole Proprietorship
A Sole Proprietorship Is the Simplest Option
A sole proprietorship is the simplest option in that you do not necessarily have to legally form a sole proprietorship. If you go out and perform work to earn income as a self-employed individual, you are technically a sole proprietor.
A sole proprietorship has no special income tax filings as all of your income and expense are filed on your personal tax return on Schedule C. You will use this Self Employment Organizer to send us your income and expense for the year.
Main Advantages of a Sole Proprietorship
- Simplicity: Simplicity is the name of the game with a Sole Proprietorship. If you earn income as a self-employed individual, you're a sole proprietor. If you receive any forms 1099-NEC, 1099-K, you likely have self-employment income and may be classified as a sole proprietor if you have no legal formation for your small business.
Potential Disadvantages
- Unlimited Liability: You are personally responsible for all financial and legal claims that may arise from your sole proprietorship, even if you have employees performing work for your business.
- Less Credibility with Customers: Put yourself in the eyes of a potential customer. An LLC or incorporated entity provides a greater degree of credibility and continuity versus no formal legal entity.
Tax Tip!
If you are operating as a sole proprietor, you should get a free Employer Identification Number (EIN) from the IRS. You can give use your EIN instead of your SSN with customers, if they request that you complete a W-9. This will help you protect your SSN and potentially protect your identity.
Limited Liability Company (LLC)
An LLC Offers Simplicity and Credibility
An LLC offers a number of benefits for business owners, with the main benefits being the simplicity in startup, operation, and management, as well as the liability protections of personal assets for the owner.
The good news is, a single-member LLC has no special income tax filings except for the Annual Form 1 and Personal Property Return noted below. All of your income and expenses are filed on your personal tax return, Form 1040, on Schedule C.
You will use this Self Employment Organizer to send us your income and expenses for the year, unless you have a Profit Loss statement that you can send to us.
Advantages of an LLC
- Limited Liability: An LLC may help limit your personal liability associated with your business activities.
- Simplicity: LLCs are simple to start and maintain as filing fees and tax filings are straightforward and generally low cost. As a single-member LLC owner, you will file your income and expense on Schedule C, which is part of your annual Form 1040 tax filing.
- Retirement Options: This is more of a self-employment benefit vs just an LLC, but you have a variety of retirement savings options if you own an LLC. This includes a Solo 401k, Simple IRA, SEP IRA, and more.
- Professional Appearance: Using an LLC adds a degree of credibility to your business, which will undoubtedly help with your marketing efforts. A business appropriate name with an "LLC" is a great way to attract customers.
- Simplicity in Income Reporting: You report your income and expenses on your Schedule C. Whatever income your earn for the year is taxable income and there are no other forms to file or worry about.
- Tax Flexibility: An LLC can elect to be taxed as a sole proprietorship or as an S Corporation. Electing S Corporation taxation offers some additional tax flexibility and potential savings, but greatly increases the complexity of your filings and record keeping requirements. This is a more advanced topic and more suitable to established businesses. See our section below on S Corporations for more details.
LLCs with Two or More Members
An LLC with two or members (partners) is considered a Partnership for tax purposes and will for a Form 1065 and any applicable state tax returns.
Items to keep in mind with a Partnership:
- Due Date: The Form 1065 (or extension) is due March 15th, not April 15th like Individual tax returns
- Form K-1: Each Partner will receive a Form K-1, which reports the partners' share of profits from the Partnership. Partnerships are pass-through for tax purposes so all profit and loss is reported on each partner's tax return, therefore, each partner must wait for a finalized Partnership return and their Form K-1, before they can file their personal tax return.
Annual Filings/Fees: In Maryland, whether a single-member LLC or Partnership, you will have the following filing requirements to keep your LLC active and in good standing. You can complete these filings online through the Maryland Business Express or we can provide these forms for you starting at $75.
Interested in more information regarding an LLC?
Or do you already have a single-member LLC and are interested in tax preparation?
Contact us to discuss any additional questions you may have.
Frequently Asked Questions
Please reach us at travis@mdtaxservice.com if you cannot find an answer to your question.
In short - no, an LLC will not directly save you any money with your tax filings.
An LLC is "pass-through" for tax purposes, so all income and expense are reported on your personal tax return on Schedule C. You will essentially have the same tax liability if you start and operate an LLC vs just operated a simple sole-proprietorship (no LLC or formation requirements).
In Maryland, you can setup an LLC through the Maryland Business Express for about $100 with additional fees depending on how soon you need your LLC to be established.
You can also use any of the online formation services like LegalZoom.com to setup your LLC, but of course the filing fees will depend on the service provider and level of services you choose.
Maryland Tax Service, Inc. does not current provide LLC setup services.
Yes, Maryland requires all LLCs to file the Annual Form 1 and Personal Property Return.
The Annual Form 1 has a $300 filing fee and is required to keep your LLC in active, good standing with the state of MD.
The Personal Property Return is also an annual filing requirement. This form reports all personal property that your business uses for a small additional tax assessment.
You can file both forms electronically through the MD Business Express for no charge ($300 filing fee still applies) or we can prepare these forms for you to mail in with your payment starting at $75.
Bookkeeping is critical to running any small business. See your Self-Employment Guide for more details on bookkeeping needs, tips, etc.
S Corporation
An S Corporation May Offer the Best Tax Savings
An S Corporation has similar startup and formation costs as an LLC, but that is really where most of the similarities end. While LLCs and S Corporations are both pass-through for tax purposes and provide limited liability protections, an S Corporation treats you, the owner, as an employee.
As an S Corporation owner/employee, you will file a separate Form 1120S and state tax filings, due on March 15th. Additionally, you must pay yourself a reasonable salary via W-2. The benefit here is that any profits above your reasonable salary can be paid out to you as a distribution, which would not be subject to payroll taxes. Additionally, you can provide tax free reimbursement for any expenses you incur, like auto mileage, home office expenses, etc. under an Accountable Plan.
You will need to provide us with an income statement and balance sheet so we can prepare your tax return. Often times, clients will use QuickBooks or another bookkeeping software to help manage their income and expense and generate the necessary financial statements.
Advantages of an S Corporation
- Limited Liability: An S Corporation may help limit your personal liability associated with your business activities.
- Retirement Options: This is more of a self-employment benefit vs just an S Corporation, but you have a variety of retirement savings options. This includes a Solo 401k, Simple IRA, SEP IRA, and more.
- Professional Appearance: Using an S Corporation adds a degree of credibility to your business, which will undoubtedly help with your marketing efforts. A business appropriate name with an "Inc" is a great way to attract customers.
- Profit Distributions: An S Corporation allows you to pay yourself profit distributions from net income, which are not subject to Social Security and Medicare taxes (about 15%). So all things equal in terms of net income, an LLC owner may pay about 15% more in taxes than an S Corporation owner.
- Accountable Plan: An S Corporation can adopt an Accountable Plan to provide tax free reimbursements of expenses to employees. See our Accountable Plan page for more details.
Disadvantages of an S Corporation
- Complexity - Reasonable Salary: You must pay yourself a reasonable salary via W-2. What is a reasonable salary? The IRS does not define what a reasonable salary is. Our advice is this: if you had to pay someone to replace you in your position, what would you pay them? Whatever you think is a reasonable salary is probably the amount you should pay yourself.
- Complexity/Cost - Payroll: You are considered an employee of your S Corporation, therefore, you must pay yourself as a W-2 employee. Running payroll comes with added costs, forms, filings, and if done incorrectly, will almost certainly result in penalties and interest. We recommend you use a payroll provider like QuickBooks, ADP, or Paychex to run your payroll.
- Complexity - Deduction Limitations: As an employee of your S Corporation, you are not allowed to deduct your expenses on your personal tax return. Common examples might include mileage, home office use, etc. An LLC owner or sole-proprietor deducts all expenses on their tax return, but running an S Corporation isn't quite that simple. Your only means to claim these deductions is to reimburse yourself through a properly established Accountable Plan.
- Complexity/Cost - Accounting Requirements: As an S Corporation owner, you are required to maintain a balance sheet. A balance sheet is a listing of your assets, liabilities, and equity. The most common way to do this is with an accounting application like QuickBooks.
- Complexity/Cost - Tax Returns: S Corporations are required to file a Form 1120S and accompanying state income tax returns annually.
Items to keep in mind with an S Corporation:
- Due Date: The Form 1120S (or extension) is due March 15th, not April 15th like Individual tax returns
- Form K-1: Each Shareholder will receive a Form K-1, which reports the shareholder's share of profits from the business. S Corporations are pass-through for tax purposes so all profit and loss is reported on each shareholder's tax return, therefore, each shareholder must wait for a finalized S Corporation return and their Form K-1, before they can file their personal tax return.
Annual Filings/Fees: In Maryland, you will have the following filing requirements to keep your S Corporation active and in good standing. You can complete these filings online through the Maryland Business Express or we can provide these forms for you starting at $75.
Interested in more information regarding an S Corporation?
Or do you already have a S Corporation and are interested in tax preparation?
Contact us to discuss any additional questions you may have.