Once you have decided that you are running a fully fledged business (rather than just a hobby) then you’ll want to be clear on exactly what sort of company you are actually running.
Firstly, it’s important to know that it is completely possible in the US to start a business without officially signing any forms or documents. It’s your activity that defines if you are running a business.
So if you open an Etsy shop today and make your first sale - congratulations, you are now running a business! This type of business structure is called a Sole Proprietorship. This essentially means that you are the singular owner of the business.
In this structure, as the sole owner, you are entitled to all profits. It also means that you are also solely responsible for all your business’s debts, losses and liabilities (this is called Unlimited Liability).
There are no specific business taxes paid by the sole prop company - the owner pays taxes on income from the business as part of his or her personal income tax payments. This is done via filing Schedule C of your Form 1040.
Although there is no official paperwork to begin your business, you’ll still want to ensure that you are fully complying with any licensing, regulations and zoning requirements in your home state.
Tip: If you have created a fictitious name for your business (otherwise known as a DBA - Doing Business As) then you’ll want to ensure you are filing all applicable forms under this name.
- Minimal startup costs
- You have complete control over the business
- You can sell or transfer your business at any time
- There are no corporate tax payments to be made
- Few formal business requirements
- You are personally liable for all debts and obligations
- You are responsible for all decisions
- This structure is not suitable if seeking outside investment
Let’s say that instead of running your business alone, you instead want to form a business with your friend and split the profits. This structure is called a Partnership. There are two common kinds of partnerships - Limited Partnerships (LP) and Limited Liability Partnerships (LLP).
Limited Partnerships have a nominated general partner with unlimited liability, and all other partners have limited liability. This means that it is only one partner that accepts the responsibility of paying off of the remainder of company debts personally if at any time the company can’t make its payments. All other partners accept liability only to the proportion of their actual share value in the business (which is typically only a very small nominal amount). In an LP, all partner profits are passed through to personal tax returns, however the general partner is also required to file self-employment taxes.
Limited Liability Partnerships differ by the fact that all partners have limited liability.
Unlike the Sole Proprietorship structure above, to form a limited partnership the partners must register in the applicable state (typically through the office of the local Secretary of State). In addition to this, it is important to research and obtain all relevant business permits and licenses - these will vary based on locality, state or industry.
Limited Liability Company
Another option is a Limited Liability Company. A LLC is basically a combination of both the corporation and partnership business structures. LLC Profits and losses can get passed through to your personal income without facing corporate taxes. You can be quite flexible in the way that you structure the members of the business and their involvement. Members of an LLC are still considered self-employed.
- You are only liable for the investment made in the company, your personal assets are protected
- Income is still passed through to personal returns
- May appear more credible and trustworthy to clients
- Formation fees can be costly, especially for a small business just starting out
- There may be ongoing costs in maintaining an LLC, such as annual report generation
- Ownership is harder to transfer
Please note that tax laws change frequently. This information is for educational and informational purposes only should not be construed as tax or legal advice. Please consult a licensed financial expert in your area with specific questions or concerns.