Best Business Entity Types for Your Marketing Agency
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If you’ve decided to take your marketing skills into the world of entrepreneurship and start your own agency, you have many decisions to make, including your business entity type. Your choice will shape your taxes and affect your personal liability.
You have several options, all of which are detailed in this guide, along with how to make the best choice for your marketing agency.
Sole Proprietorship
The simplest choice is to choose a sole proprietorship if you’re going to be the only owner of your agency. You’ll be operating as a sole proprietorship by default if you just start doing business and don’t register a business entity with the state.
With a sole proprietorship, you and the business are considered one and the same, which has several implications.
One, your agency name must be your name unless you register a “doing business as” (DBA) name.
Second, all the profits of the business will pass through to you to be reported on your personal tax return, and the business will not be taxed separately.
Third, and most importantly, you are personally liable for the debts and obligations of the business. That means if the business cannot pay its debts or is sued, your personal assets could be at risk. While it might seem that a marketing agency is at low risk for a lawsuit, it is certainly possible that a legal situation could arise.
While a sole proprietorship costs nothing to form and gives you a lot of flexibility, the personal liability aspect is a significant downside.
General Partnership
If you’re going into business with someone else and you don’t form a business entity, you’ll be operating as a general partnership by default. In a partnership, just like a sole proprietorship, the owners and the business are one and the same, and the same implications apply.
A general partnership, however, must file Form 1065, a U.S. Return of Partnership Income, but it’s for informational purposes only. The partnership itself is not taxed.
It’s also highly advisable to have a partnership agreement that defines ownership, profit distributions, partner roles and responsibilities, and more. Ideally, an attorney should draft this agreement.
Again, personal liability is the downside of a general partnership.
Corporation
A corporation is more complex than a sole proprietorship or partnership. It must be registered with the state and create corporate bylaws. It must also elect a board of directors, appoint officers of the corporation, and follow other state requirements regarding corporations.
A corporation is also subject to corporate taxes, and dividends paid to the owners (called shareholders) are also taxable. This is commonly referred to as double taxation since some of the profits of the company are being taxed twice.
However, a corporation is a separate entity from its shareholders, so shareholders are not personally liable for the obligations of the corporation.
Limited Liability Company (LLC)
A limited liability company (LLC) offers the best of both worlds. Like a corporation, the LLC is a separate entity from its owners, called members, and are thus not personally liable for the obligations of the LLC.
An LLC also offers the pass-through taxation of a sole proprietorship and a general partnership. If the LLC has one member, it’s considered a sole proprietorship by the Internal Revenue Service (IRS), and a general partnership if it has more than one member.
An LLC must be registered with the state, which requires filing a document, usually called the articles of organization, which comes with a fee. An LLC, however, comes with few requirements, unlike a corporation.
An LLC should have an operating agreement, which will define member ownership percentages, profit distributions, the management structure, voting rights of members, and more.
LLCs are a popular choice for entrepreneurs of all types. You can find LLC guides and resources to learn more.
S-Corp Status for an LLC
Now let’s discuss a bit of a caveat that comes with LLCs.
First of all, LLC members are subject to self-employment taxes (as are sole proprietors and partners) which fund Medicare and Social Security.
But LLCs are unique in that they can elect S-Corp tax status if it meets certain qualification requirements. An S-Corp still offers pass-through taxation, but it comes with corporate requirements, and managing members must be paid a reasonable salary before any profit distributions are taken. That salary is subject to normal employment taxes, which also fund Medicare and Social Security.
But the benefit of an S-Corp is that profits distributed after salaries are paid are not subject to self-employment taxes, which can give members a nice break on their taxes.
S-Corp status, however, comes with corporate administrative costs including payroll expenses. This means that for S-Corp status to be financially beneficial for the LLC members, the self-employment tax savings must be greater than the corporate expenses.
The tax status choice is as complicated as it sounds and is best made with the help of a professional tax advisor.
S-Corp status can be elected by filing Form 2553 with the IRS.
Making the Choice
Sole proprietorships and general partnerships offer simplicity but come with personal liability for members.
In many cases, an LLC is the best choice because it offers the best of both corporations and sole proprietorships and partnerships.
However, if you’re planning to raise capital from investors for your marketing agency, a corporation may be a better choice. Investors prefer corporations because the ownership, expressed in shares, is easier to transfer in exchange for capital than the ownership of an LLC, which is expressed in percentages.
If you’re not planning to raise investment capital, though, an LLC is a better choice than the alternatives in most cases, because an LLC offers asset protection and pass-through taxation.
In Closing
Your business entity decision is an important one, but now you have all the information that you need. If you’re still in doubt, though, be sure to consult with your attorney and tax advisor. They can help you to make the correct choice that will give you and your marketing agency the best chance of success.
