How Web Agencies Are Commonly Structured, and What to Ask a Lawyer

Three arrangements come up most often when a web design business gets set up. A sole proprietorship. A single-member LLC. An S corporation election. The first is a default you fall into. The second is a separate legal entity, created by state law. The third is not an entity at all. It is a tax election, layered on top of one you already have.

What a sole proprietorship actually is, and what it is not

• Nothing creates it. The IRS defines a sole proprietor as someone who owns an unincorporated business by themselves. There is no form that starts one.
• Income tax runs on your own return. Form 1040 with Schedule C, Profit or Loss from Business.
• Self-employment tax runs on Schedule SE. The IRS puts the self-employment tax rate at 15.3%: 12.4% for Social Security, 2.9% for Medicare. The Social Security portion stops at an annual wage base that changes each year. The Medicare portion does not stop.
• You and the business are one person. There is no second party to the contracts you sign.

The thing it is not: a registration you complete. People often say they registered as a sole proprietor. What they usually registered is a business name. Those are different acts. In Florida, section 865.09 of the statutes says a person may not engage in business under a fictitious name without registering it first. The filing goes to the Division of Corporations. A second step comes with it. One registrant has to certify that the intent to register was advertised at least once in a newspaper, in the county where the business sits. Registering a name does not create a company. It records who is behind a name.

What a single-member LLC changes, and what it does not

What changes:

• There is now a second legal person. The IRS describes an LLC as an entity created by state statute. Contracts, the domain, the bank account and the hosting can be held by the company instead of by you.
• A liability rule attaches to it. Under Florida Statutes section 605.0304, a debt of an LLC is solely the debt of the company. A member is not personally liable for it solely by reason of being or acting as a member.
• Sloppy paperwork is not, by itself, fatal. The same section says the failure to observe formalities is not a ground for imposing liability on a member. That is Florida’s text. Other states write their own.

What does not change:

• Federal income tax, by default. The IRS treats a one-member LLC as an entity disregarded as separate from its owner unless the LLC elects otherwise. The activity lands back on the owner’s Schedule C, E or F.
• Self-employment tax. The IRS says an individual owner of a single-member LLC running a trade or business pays tax on net earnings from self employment. That is the same treatment a sole proprietorship gets.
• Employment and certain excise taxes. For those, the IRS still treats the single-member LLC as a separate entity.

Two words in the Florida statute do a lot of work: solely by reason. The rule addresses liability that would attach to a person only because they are a member. Any other route to the same person is a separate question. It turns on the facts, on that state’s version of the act, and on how courts there have read it.

The S corp election is a tax election, not an entity

• No state office forms one. The IRS describes S corporations as corporations that elect to pass income, losses, deductions and credits through to their shareholders. The election is federal.
• An LLC can make the election. The Instructions for Form 2553 cover more than corporations. Any entity eligible to be treated as a corporation uses that form to elect S status. Such an entity does not need to file Form 8832 as well. The state-law form of the company is untouched.
• There are qualifying tests. The IRS lists them: a domestic corporation, only allowable shareholders, no more than 100 shareholders, one class of stock, and not an ineligible corporation. Partnerships, corporations and non-resident alien shareholders are not allowable.
• There is a deadline. Form 2553 is filed no more than 2 months and 15 days after the tax year begins. The other window is any time during the tax year before it.
• It adds filings. Form 1120-S, a Schedule K-1 for each shareholder, and payroll.

The part that gets least attention is compensation. The IRS position is that an S corporation must pay reasonable compensation to a shareholder-employee for services before non-wage distributions are made. It can also reclassify distributions as wages. The IRS cites court decisions backing that authority, including David E. Watson, PC v. U.S., 668 F.3d 1008 (8th Cir. 2012). What counts as reasonable turns on what the shareholder actually did and where the receipts came from.

What registering costs, by state

Five states, each figure taken from the office that charges it:

• The filing fee is not the running cost. California’s Franchise Tax Board says every LLC organized or doing business in the state owes an annual tax of $800. It is due whether or not the company is trading, until the LLC is canceled. That is a separate agency from the Secretary of State, and a separate bill.
• Texas charges more to register an out-of-state entity than to form one. Its schedule prices a Texas certificate of formation at $300. A foreign entity application for registration is $750. The same schedule adds a late filing fee. It applies to a foreign entity that has transacted business in Texas for more than ninety days without registering.
• New York adds a publication step. An LLC there publishes notice in two newspapers within 120 days of formation. Then it files a Certificate of Publication for $50. The Department of State says companies that miss the window have their authority to transact business suspended.
• These are the state’s charges only. They do not include a registered agent service, an accountant, or a lawyer. Fees move, so every row above links to the office that publishes those figures.

The questions worth taking to an attorney

These are the questions a licensed attorney in your state can answer. Answers are not on this page, on purpose. See the note at the bottom.

• For the work I do, in the state where I do it, does any of this change my exposure?
• Does my state’s LLC act use the same solely by reason language Florida does? How have courts here read it?
• What is left outside that protection? Does professional liability insurance sit there instead?
• What happens to client contracts I already signed in my own name if I form an entity later?
• When does a client in another state mean I am transacting business there? What does that require?
• If I subcontract design or development work, does that change any of the above?
• What does my state require if I trade under a name that is not my legal name?
• For a CPA or tax attorney: is an S corporation election available to me? By when would it have to be filed? What would reasonable compensation mean on my facts?
• What separation between me and a company I own does my state expect? In records, in banking, and in how I sign things.