In addition to considering the type of salon or spa that you want to open, you also need to decide on a salon business structure that works for you. According to the Small Business Administration, your business structure in the United States affects how much you pay in taxes, your ability to raise money, the paperwork you need to file, and your liability.
Before you register your business with the state, you’ll need to choose a business structure for your salon. Most companies are also required to get a tax ID number and file for the appropriate licenses and permits.
It’s advised to take the time to consult with a CPA and/or attorney so that you can choose your salon business structure carefully. It’s possible to convert to a different business structure in the future, but there might be restrictions based on your location. Changing your business structure could also result in tax consequences and unintended dissolution, among other complications, so choose wisely.
Common Salon Business Structures
A sole proprietorship is simple to form and allows you to have complete control of your business. You are automatically considered to be a sole proprietorship if you conduct business but don’t register as any other kind of business.
Sole proprietorships do not operate as a separate business entity, so your business assets and liabilities are not separate from your personal assets and liabilities. This means that you can be held personally liable for the debts and obligations of the business. Sole proprietors are still able to obtain a trade name. Sole proprietorships can be a good choice for low-risk companies and owners who want to test their business idea before forming a more formal business. However, with this type of business structure, it can be hard to raise money because you can’t sell stock, and banks are hesitant to lend to sole proprietorships.
Partnerships are the most straightforward structure for two or more people to own a business together. There are two common kinds of partnerships: limited partnerships (LP) and limited liability partnerships (LLP).
Limited partnerships have only one general partner with unlimited liability, and all other partners have limited liability. The partners with limited liability also tend to have limited control over the company, which is documented in a partnership agreement. Profits are passed through to personal tax returns, and the general partner, the partner without limited liability, must also pay self-employment taxes.
Limited liability partnerships are similar to limited partnerships but give limited liability to every owner. An LLP protects each partner from debts against the partnership, and they won’t be responsible for the actions of other partners.
Partnerships can be a good choice for businesses with multiple owners, professional groups (like attorneys), and groups who want to test their business idea before forming a more formal business.
Limited Liability Company (LLC)
An LLC lets you take advantage of the benefits of both the corporation and partnership business structures. LLCs protect you from personal liability in most instances. Should your LLC face bankruptcy or lawsuits, personal assets such as your vehicle, house, and savings accounts, won’t be at risk. Also, profits and losses can get passed through to your personal income without facing corporate taxes. However, members of an LLC are considered self-employed and must pay self-employment tax contributions towards Medicare and Social Security.
LLCs can have a limited life in many states. When a member joins or leaves an LLC, some states may require the LLC to be dissolved and re-formed with new membership, unless there’s already an agreement in place within the LLC for buying, selling, and transferring ownership.
LLCs can be a good choice for medium or higher-risk businesses, owners with significant personal assets they want to be protected, and owners who want to pay a lower tax rate than they would with a corporation.
A corporation, sometimes called a C corp, is a legal entity that is separate from its owners. Corporations can make a profit, be taxed, and can be held legally liable. Corporations offer the most reliable protection to its owners from personal liability but the cost to form a corporation is higher than other structures. Corporations also require more extensive record-keeping, operational processes, and reporting.
Unlike sole proprietors, partnerships, and LLCs, corporations pay income tax on their profits. In some cases, corporate profits are taxed twice: first, when the company makes a profit, and again when dividends are paid to shareholders on their personal tax returns. Corporations also have a completely independent life separate from its shareholders. If a shareholder leaves the company or sells his or her shares, the C corp can continue doing business relatively undisturbed.
Corporations have an advantage when it comes to raising capital because they can raise funds through the sale of stock, which can also be a benefit in attracting employees.
In short, corporations can be a good choice for medium or higher-risk businesses, businesses that need to raise money, and businesses that plan to “go public” or eventually be sold.
An S corporation or S corp is a particular type of corporation that’s designed to avoid the double taxation drawback of regular C corps. S corps allow profits, and some losses, to be passed through directly to owners’ personal income without ever being subject to corporate tax rates.
Not all states tax S corps equally but most recognize them the same way the federal government does and taxes the shareholders accordingly. Some states tax S corps on profits above a specified limit and other states don’t recognize the S corp election at all, merely treating the business as a C corp.
S corps must file with the IRS to get S corp status, a different process from registering with their state. There are also particular limits on S corps. For example, S corps cannot have more than 100 shareholders, and all shareholders must be citizens of the United States. You’ll still have to follow strict filing and operational processes of a C corp. S corps also have an independent life, just like C corps. If a shareholder leaves the company or sells his or her shares, the S corp can continue doing business relatively undisturbed.
S corps can be a good choice for a business that would otherwise be a C corp but meet the criteria to file as an S corp.
A benefit corporation or B Corp is a for-profit corporation recognized in most U.S. states. B Corps are different from C corps in purpose, accountability, and transparency but aren’t different in how they’re taxed.
Both mission and profit drive b Corps. Shareholders hold the company accountable to produce some public benefit in addition to a financial profit. Some states require B corps to submit annual benefit reports that demonstrate their contribution to the public good.
There are several third-party B Corp certification services, but none are required for a company to be legally considered a B Corp in a state where the legal status is available.
Close corporations resemble B corps but have a less traditional corporate structure. These shed many formalities that typically govern corporations and apply to smaller companies. State rules vary, but shares are usually barred from public trading. A small group of shareholders can run close corporations without a board of directors.
Nonprofit corporations are organized to do charity, education, religious, literary, or scientific work. Because their work benefits the public, nonprofits can receive tax-exempt status, meaning they don’t pay state or federal taxes income taxes on any profits it makes. Nonprofits must also file with the IRS to get tax exemption, a different process from registering with their state.
Nonprofit corporations need to follow organizational rules very similar to a regular C corp. They also need to follow special rules about what they do with any profits they earn. For example, they can’t distribute profits to members or political campaigns. Nonprofits are often called 501(c)(3) corporations — a reference to the section of the Internal Revenue Code that is most commonly used to grant tax-exempt status.
A cooperative is a business or organization owned by and operated for the benefit of those using its services. Profits and earnings generated by the cooperative are distributed among the members, also known as user-owners. Typically, an elected board of directors and officers run the cooperative while regular members have the voting power to control the direction of the cooperative. Members can become part of the cooperative by purchasing shares, though the amount of shares they hold does not affect the weight of their vote.
Designations like S corp and nonprofit aren’t strictly business structures; they can also be understood as a tax status. It’s possible for an LLC to be taxed as a C corp, S corp, or a nonprofit. These arrangements are far less common and can be more challenging to set up. If you’re considering one of these non-standard structures, you should speak with a business counselor or an attorney to help you decide.
This article has been curated from the Small Business Association.