What is a DBA? What is an LLC?
The two business models that you should definitely consider as you start a business in America are Doing Business As (DBA) and Limited Liability Companies (LLC). DBA is the more basic of the two and is considered a simple cost-effective solution for businesses. An LLC is more sophisticated, but offers a significant amount of protection for small business owners.
A DBA also known as a fictitious name or assumed name provides an alternate business identity. If Tom Jones, the health insurance agent wants to call his business even more specifically "Tom’s Insurance Store" instead of Tom Jones Insurance Agency, he can file a DBA with the state to use this alternate name. Tom would then file his taxes and legal documents under the name "Tom’s Insurance Store." A DBA has no tax advantages and doesn’t affect the tax treatment of the underlying corporation or small business corporation . You still file taxes under your true name.
Limited Liability Companies offer limited liability while also avoiding double taxation and corporate formalities. An LLC is created by filing a certificate with the state Secretary of State. LLCs afford their owners limited liability and there are many tax advantages to an LLC if done properly. If you run your coffee shop as an LLC rather than a DBA, you can position yourself to avoid personal liability for company debts, and you can take advantage of the favorable tax treatment offered to LLCs. For example, you may not have to pay corporate taxes on your profits. Instead, you can take your share of profits from the company and include them in your own personal income tax return, similar to an S Corporation. That prevents the double taxation that corporations sometimes incur. If you need protection from shareholder liabilities and creditiors, an LLC is the way to go.
Tax Structure of a DBA
When it comes to taxes, a DBA operates in a straightforward manner. If you choose to conduct business under a DBA without forming an LLC, you will need to include that business income on your personal tax return if you are the sole owner of your business. You are also responsible for paying self-employment taxes, as the IRS taxes your income at the personal level rather than by issuing a separate, business-level tax.
The main benefit of filing taxes this way is that you avoid the additional tax burden that comes with an LLC. Because an LLC is a pass-through entity, a single-member LLC and a sole proprietorship taxed like a single-member LLC file their tax returns in the same manner. In other words, it won’t benefit you financially to create an LLC and choose to file your income as a sole proprietor.
The downside to being a sole proprietor, however, is that you are personally liable for all debts and legal obligations that arise from your business. In contrast, forming an LLC gives you limited liability protection, which means you won’t be held personally responsible for the business debts or any legal claims made against your company.
Tax Benefits of forming an LLC
An LLC enjoys pass-through taxation, meaning it is not taxed at the business level but the tax liability is passed through to the members, who report pass-through income on their tax returns. This avoids double taxation that C corporations face, where income tax is paid both on the corporate level and at the personal level when profits are distributed as dividends. By avoiding double taxation, members of an LLC can potentially pay a lower overall tax bill than they would pay with a corporation.
An LLC can elect to be treated as an S-corporation for tax purposes if it meets eligibility requirements, such as being a domestic corporation that has no more than 100 shareholders and having only one class of stock. If the LLC elects S-corp treatment, income, losses, credit and deductions are passed through to the shareholders based on their percentage ownership. The key difference from partnership taxation is that dividends paid are tax free for shareholders of S-corporations; S-corporation shareholders pay taxes only on wages and other income passed through.
LLC members can deduct business expenses on a Schedule C (single-member LLC) or Schedule E (multi-member LLC) of their personal tax returns, as appropriate. This flexibility allows LLCs the opportunity to take full advantage of all the business deductions available under the Internal Revenue Code.
Tax Brackets For LLC’s and DBA’s
When you operate as a Sole Proprietor, the majority of your business earnings become part of your personal income on your tax return. You are subject to the full individual income tax rates and also self-employment tax — a sizable cost for many business owners.
To add to the burden, all of your business transactions are recorded on your personal income tax return. The result? A cumbersome tax collection and auditing process by the IRS.
If you receive a 1099-MISC for your services , the issuing company will report your earnings to the IRS and an IRS Cross Match Program cross references all 1099-MISC transactions. That means getting reported from larger or more established businesses could invite an inquiry on your accounting practices, means of record keeping and taxation.
Tax consequences when owning and operating a business under DBA can put a dent in your earnings and generate transactional red flags. Embracing the LLC option brings a more tax-efficient method of owning and operating your business with less potential for IRS cross-referencing.
Which Entity Type is the best for your business?
A variety of factors can determine what business structure makes sense for your small business and what business structure has the potential for the most valuable tax advantages. Owner-operators of single entrepreneurs should exercise discretion and carefully consider their options to help maximize tax advantages. The most basic distinction between a DBA and LLC is that a DBA confers no legal protection on your assets, and an LLC offers you that protection. However, if you’ll have no need for that protection, and you’re buying inexpensive items in your business, then a DBA will probably fit you well. On the other hand, an LLC will likely be the best fit for a business owner who plans to: Look at your current and future business needs, risk profile, business exit strategy, and how taxes impact your overall personal finances to determine the perfect business structure for your small business. A DBA is cheaper than an LLC because it is far easier to create and operate. LLCs are more complicated, but because of that complexity, they can offer exceptional rewards. A DBA is more of a go-backwards sort of setup — it’s a good choice if you want to avoid liability that can catch up with you later, but there’s nothing much else sweet about it. An LLC is appropriately named. It limits liability, which is absolutely worth something.
Conclusion: Choosing Wisely
In the US legal structure, both "doing business as" (DBA) and limited liability company (LLC) have their own tax advantages and formats in which they may be beneficial to your business. You must think about what your business requires and which tools you may need to be successful. If you are in a line of business in which profits and losses are low, or if you prefer the ease of filing annual tax returns , then the DBA structure may work for you. If you require more structure and limited liability (though you will still be liable for debts and losses), an LLC may be right for you.
Bear in mind that the various advantages and disadvantages we discussed here in this article must be considered together so that you can arrive at the best answer for your individual circumstances.