As you consider your company’s legal structure, you’ve probably had these thoughts:
- Should I incorporate?
- What’s an LLC?
- Can I just be a business without all the legal mumbo jumbo?
Because I am not an attorney, I will not provide legal advice. What I can help you with is the credit-building side of these decisions.
The rules of business credit are dramatically different from the rules of personal credit.
Here are a few comparisons:
- To rapidly raise your personal credit scores, you need to keep credit card use below 10 percent of the limit on any account. To rapidly raise your business credit scores, you need to charge any amount (up to account limits) and pay the bills before invoices are generated by creditors.
- When you max out any personal credit card account, your credit scores will usually drop 100 to 150 points. When you max out a commercial account, your business credit scores are not affected in any way.
- Having numerous personal credit card accounts can diminish your personal credit scores because you can be penalized for having access to ‘too much’ credit. Businesses can open as many accounts as necessary; your business credit scores are determined by your payment history.
We begin with this premise: you must separate business credit from personal credit because the rules differ. You don’t want your personal credit destroyed by normal commercial account transactions.
Many small businesses choose this option because it’s easy. You decide you’re in business and you are. From a credit-building perspective, it can be more difficult to separate your personal credit from your business credit because you will probably be required to provide a personal guarantee for your commercial accounts. This means account activity for your business will be reported on your personal credit reports, where usage will be evaluated as if it’s a personal account. You cannot deduct fringe benefits, such as health insurance and retirement accounts as business expenses. And you are personally liable for all debts. You might choose to start as a sole proprietor, while you evaluate the best long-term business structure for your company.
These are businesses formed by more than one person. Income is distributed among partners. It functions much the same as a sole proprietorship, with similar advantages and disadvantages
A popular choice of micro-businesses, profits pass through to you as an individual taxpayer, which means you avoid paying corporate taxes. As a legal entity, it offers some personal liability protection and it’s simpler to form than a C corporation. If you follow the guidelines in Why You Don’t Need Intermediaries to Build Business Credit and its linked articles, you will easily separate business credit from personal credit. However, it’s important to remember that fringe benefits, such as health insurance, are passed through as income for anyone who owns more than 2 percent of an S corporation unless insurance is a corporate group plan, which requires a minimum of two employees to qualify. If you are a single employee company with pre-existing medical conditions which increase your insurance costs substantially, you want a skilled CPA to evaluate the best corporate structure for deducting ongoing insurance and medical expenses.
Limited Liability Company – LLC
During the past decade, LLCs have grown in popularity. More states recognize LLCs as preferential corporate structures, when there is more than one owner. IRS rules allow an LLC to choose between taxation as a partnership or corporation. However, not all state laws reflect this change. Owners’ liability for business debts is limited, as it is in a C corporation. And if the LLC is taxed as a corporation, fringe benefits can be deducted as they would be in a C structure. Keeping personal and business credit separate is simplified with an LLC, which enhances your business credit history and the ability to establish commercial accounts without a personal guarantee.
This is the same legal structure used by major corporations. It offers the widest breadth of deductions and tax advantages. Owners are not liable for company debts. And, in many states it’s available for solo business owners. Check the secretary of state’s website for your state to determine the applicable regulations. A friend recently incorporated her extraordinary new organic candy company, Fat Ass Fudge, as a C corporation by phoning the attorneys at LegalZoom. More artisan than executive, she reported they walked her through the whole painless process one night. She is not concerned about the regular reports she must file because she sees that none need to be complex for her business. The C structure keeps her sweet company income separate from family finances. From the credit perspective, C corporations and LLCs (in most states) form the best foundations to build business credit.
In addition, there are nonprofit corporations and other partnership structures, especially for specific licensed professions. Individual circumstances will determine the best legal structure for you. I encourage you to consult an attorney or CPA, who specializes in small businesses, to assist you with decisions that provide you with optimum financial benefits.