Once you have begun to establish a new business, you will face the daunting task of deciding which type of business it will be.
With several different options, how can you know which type of corporation is the best way to go?
My overview of each corporation type should give you a good idea of which one is best for your company.
In Summary, S-Corporation is great for self-employed entrepreneurs if you’re making more than $80k/year. If you’re making less than $80k/year, LLC is better.
Also, keep in mind that the biggest disadvantage of C corporations is that they are “double taxed.” When a C corporation earns income, the C corporation is taxed. Then anytime the corporation issues a dividend, the shareholders are taxed on the amount they receive. As a result, the income is “taxed twice.”
On the other hand, an S Corporation is a special type of corporation created through the IRS. By electing to be treated as an S Corporation, the corporation can avoid double taxation.
What makes the S Corporation different from a traditional C Corporation is that profits and losses can pass through to your personal tax return. What this means is that the business itself is not taxed; only the shareholders are taxed.
If you’re still not sure about which type of corporation is right for you, email me at firstname.lastname@example.org
Types of Corporations
There are 2 main types of corporations in the United States: S corporation (also called an “S corp”), and a C corporation (or C Corp).
Each type of corporation is formed in different ways, with its own combination of advantages and drawbacks.
Your particular state or locality also may have its own set of rules for each classification.
What is an LLC?
An LLC is the simplest business structure available, with few rules on how the business must be structured.
Many small businesses can begin as an LLC before changing its designation.
Although it has a little more flexibility than what we usually consider to be a corporation, an LLC shares some similarities with traditional corporations.
With an LLC, the profits and losses of the business are the profits and losses of the owners. In contrast, a traditional corporation is considered a separate business entity and any profits and losses are taxable to the corporation, not the owners.
With all forms of corporations, including LLCs, owners have limited liability from any debts or lawsuits against the business. As the owner of an LLC, you are not personally responsible for company debts or lawsuits, unless criminal behavior is involved.
PLUS, being able to use “LLC” in your business name gives you added credibility–and not just with customers. Forming an LLC allows you to build credit as a business and take out business loans from financial institutions.
Advantages of LLC
Owners of an LLC have to deal with less paperwork and fewer taxes than other types of corporations. The owners receive the LLC’s profits directly, and report them on individual tax returns, in a system called “pass-through taxation.”
An LLC does not have to have formal roles (such as a CEO) or hold annual meetings. Even if you’re the only owner, and have no employees, you can still register as an LLC.
Disadvantages of LLC
The main disadvantage of an LLC is that it cannot be listed on the stock market. This could prevent it from obtaining venture capital funding.
An LLC also may not be recognized as a viable business outside of the United States.
How to Form an LLC
The process of forming an LLC is a little different in each state, but there are some general steps that they all follow.
To form an LLC, you will have to pick a unique name for your business and file its “articles of organization” with the appropriate department in your state. The articles include basic information such as the business name, address, and member names.
To create an LLC, you also must obtain the business permits required for your city, state, and industry. You should also file Form SS-4 with the IRS, and obtain an Employer Identification Number (EIN).
Some states require an operating agreement that includes certain financial information, but not all states require you to file this document. Once you have formed your LLC, your state may require you to have a statement about your LLC formation in a local newspaper.
The U.S. government’s Small Business Administration website can be a great resource for small business owners interested in forming an LLC, with tips for writing a business plan and finding the best employees.
Interested in forming an LLC?
Email me at email@example.com to start the process and learn all you need to know!
What is an S Corp?
An S corp is a type of corporation, created with the IRS that passes corporate income, losses, deductions, and credits through to its shareholders. These shareholders then report the flow-through of income and losses on their personal tax returns and are taxed at individual rates, rather than the business itself being taxed.
This allows the S corp to avoid “double taxation.” In “double taxation,” business profits are taxed before being distributed to owners and are then taxed a second time when the owners report these profits on their individual tax returns.
An LLC may be able to request S corp status from the IRS.
If you’re looking to form your S-corporation, email me at firstname.lastname@example.org
Advantages of S Corp
The advantages of an S corp include more tax savings than with an LLC. Members of an LLC are subject to employment tax on the business’ entire net income, but with an S corp, employment tax only applies to the wages of an S corp shareholder who is also an employee.
As an S corp, a business can also exist independently of its shareholders. This can protect the shareholders, and also keep business operations smooth if a shareholder leaves the company.
Disadvantages of S Corp
Compared to an LLC, an S corp has more requirements and restrictions on how it is structured. An S corp must have scheduled director and shareholder meetings, keep minutes and by-laws, and maintain certain records.
Any shareholder who also works for the company must receive “reasonable compensation,” or else the IRS could reclassify additional corporate earnings as “wages.” As a result, the business could pay a higher employment tax.
An S Corp cannot have more than 100 shareholders, limiting its potential growth and investment compared to other types of corporations.
How to Form an S Corp
First, you have to file as a corporation with the IRS. Then, all shareholders must sign and file Form 2553, with which they elect your business to become an S corp.
As with an LLC, the business must receive the appropriate licenses and permits, depending on your state.
For an overview, search your state’s website for its particular rules on business structures. You may also want to perform a similar search for your locality.
Interested in turning your company into an S corp? Contact me at email@example.com to learn more!
What is a C Corp?
The C corporation is the most common type of corporation in the United States. As a C corp, there is no limit to how much your company can grow!
A C corp can sell stocks and can have an unlimited number of shareholders. Like a corporation, this type of business is independent of the people who own and manage it, and so is considered a legal “person” under tax laws.
Advantages of a C Corp
A C corp carries numerous advantages, especially for those companies that hope to grow and win investors.
There are particular advantages for non-personal service corporations (non-PSCs), such as low tax rates on the first $75,000 of annual income. In a PSC, more than 10% of the stock by value is owned by professionals who provide the company with personal services such as accounting, consulting, engineering, or the law.
C corps also have better fringe benefits for owner-employees, such as the ability to use a medical reimbursement plan. There is also a reduced rate of capital gains tax on the sale of qualified small business stock.
Venture capital may be easier to come by for a C corp. Ownership arrangements can be more flexible with this classification, and so are more appealing to financiers.
C corp classification is necessary for shares to be traded on a public exchange. Therefore, your business should be designated a C corp if you expect it to grow and go public.
Disadvantages of a C Corp
Classification as a C corp includes several distinct disadvantages, as well. This is particularly the case in terms of taxation.
A C corp will see double taxation of appreciated assets when they are sold or dissolved. Profits are first taxed to the company, and then taxed a second time once distributed to shareholders as dividends.
C corps must pay higher corporate income tax rates when the annual income exceeds $75,000.
C corps also come with more complicated paperwork and must file numerous tax forms at all levels of government. This includes IRS Form 1120, W-2s, and 1099-DIV.
The additional taxes and paperwork usually mean that you will have to hire an accountant to help out, further adding to the expense and paperwork of owning a business.
How to Form a C Corp
As with the other types of companies, you must choose the state to set up in, and familiarize yourself with federal, state, and local laws for C corporations. It is a good idea to hire a business attorney to help you with every step of the process.
You also must write the articles of incorporation, which serve as a public charter for the company. Check with your state to determine which details have to be included in the articles.
Generally, the articles of incorporation should include the company name and address, a general description of the business activity, the designation of a registered agent who can receive legal notices, information about stock, and the person or company responsible for filing the required forms.
A C corp also must have written by-laws and shareholder agreements that govern how the company will be run, including where and when meetings will take place.
The C corp also must pay taxes, and file a return by March 15, a month earlier than the standard “Tax Day.” Other details include obtaining an EIN, other licenses and permits, and business insurance.
Ready to form a C corp? Email me at firstname.lastname@example.org to get the ball rolling!
S Corp vs C Corp
Since they are both corporation types, there are numerous similarities between an S Corp and a C corp. Both types are separate legal entities from their owners and are governed by a board of directors.
Also, either choice is recognized as a corporation in all 50 states, and outside of the United States. Both types of corporations protect personal assets from business liability and require that business and personal finances be separate.
How to Tell if a Company is S Corp or C Corp
Despite their similarities, of course, there are obvious differences between S and C corporations. These differences primarily involve taxes and investment.
A C corp is a separately taxable entity that reports profits and losses on a corporate tax return. Profits are taxed at the corporate level, and losses do not pass through for use by shareholders.
In comparison, an S corp is called a “pass-through” tax entity because the corporate level does not pay tax. Instead, profits and losses are passed through the corporation to the shareholders’ individual tax returns, where the profits and losses are reported.
Besides being limited in the number of shareholders, S corps are also limited to certain kinds of shareholders. All shareholders of an S corp must be U.S. citizens or legal residents, and generally must be individuals.
In contrast, C corporations can have shareholders that are outside of the United States, and that are other corporations, LLCs, partnerships, or trusts. C corporations can have different classes of stock, while S corporations can have only one.
If a corporation becomes an S corp, it must file Form 2553 with the IRS, after all the shareholders have agreed to it in writing.
For more details on the differences between an S Corp and a C corp, check out my earlier blog post discussing these two types of businesses.
How to Choose S Corp or C Corp
Ultimately, the choice between S corp or C corp comes down to your business goals.
If you intend to grow your business and eventually take it public, then it makes the most sense to become a C corp. Otherwise, your company will have limited investment options.
Small businesses that plan to stay small would do best to choose the S corp designation. Otherwise, double taxation will incur heavy costs and carry little benefit.
Since no one can thoroughly predict the future, of course, you can always change your business designation later on. But to save on paperwork and future hassle, it helps to create a solid business plan and be aware of your options now.
Not sure you should even form a corporation? Check out my earlier blog post on the Professional Corporation your business!
To choose the right type of corporation, carefully consider the advantages and disadvantages of each type of C Corporation and S Corporation.
Think about your short- and long-term business goals, and how each classification can help you reach them.
Fortunately, you don’t have to decide these things on your own–nor should you. A qualified business attorney can help you navigate the pros and cons, come to the right decision, and complete all the necessary paperwork.
Ready to get started? Contact me Sam Mollaei Esq., business lawyer, today at email@example.com to take the next step!
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