**This article is co-authored by Sawsan Selim
From the onset of formal education, young students are taught that entrepreneurs are the risk-takers of society. However, good entrepreneurs do not take blind jumps and hope for the best. Quite the contrary; successful entrepreneurs are those who take calculated risks and make good decisions at the get-go. The longevity and prominence of one’s company begins right at choosing the most appropriate business model for one’s endeavors. What business models exist and which one should you take up as yours? Let’s discover that answer together.
When you are ready to evolve from being a sole or general proprietorship to operating a company that is recognized by the state and is its own legal business entity (separate from its owner(s)), you are, by definition, incorporating your business. Depending on the company structure you choose, incorporating a business offers many benefits, including liability protection, tax deductions, and the ability to raise capital through sale of shares of your company. From the realm of incorporation comes two common company structures: a LLC and a Corporation.
LLC: What It Is
LLC stands for Limited Liability Company and is generally considered to be the least complex business structure due to its flexibility. It is essentially a hybrid company structure that takes elements from a partnership or sole proprietorship and combines them with elements of a corporation. One thing to note is that an LLC does not sell shares of stock; rather there is “membership interest”. Membership interest expresses ownership in an LLC and holders of membership interest have voting and profit interest in the company. Furthermore, as the title “Limited Liability Company” suggests, members of the company cannot be held personally liable for the company’s debts or liabilities.
Besides Limited Liability, What Are Some of the Advantages That Come With a LLC?
- Tax Flexibility. For taxation purposes, the Internal Revenue Service (IRS) does not recognize an LLC as a separate entity (to be taxed). Simply put, the IRS will not tax the LLC directly and the members of the LLC choose how taxation will occur for them. What taxation options are there?
- You can choose to operate as a single member LLC which is treated like a sole proprietorship. Profits and losses are taxed through the single members’ personal tax return.
- Choosing to operate as partners in an LLC will allow you and your partners to be taxed like a traditional partnership.
- Lastly, you can be an LLC filing as a Corporation. Like the classification suggests, the IRS will treat your company as a corporation and will tax you as such.
Note: ensure you outline how you wish to be taxed in your Operating Agreement.
- Flexibility in Management. LLCs do not have to have a formal management structure of directors and officers.
- Less Paperwork. Part of the flexibility of a LLC entails not having stringent requirements to follow. This means more ease in actually creating the LLC and keeping it in good legal standing.
- Enhanced Credibility. Operating through an LLC will generally make you look more credible to partners, suppliers, and lenders.
- No Residency Requirement. You do not have to be a U.S. Citizen or a Legal Permanent Resident of the United States to create an LLC.
Alright, So What About a Corporation?
Like a LLC, a corporation is its own separate legal entity. One of the key elements that differentiate a corporation and a LLC is that a corporation must have a board of directors/ group of officers. Within the world of corporation itself, two common business structures emerge: C-corporation and S-corporation.
What Is A C-Corporation?
A C-Corporation is one of the oldest and the most common business entity in the United States. It is a business that is owned by individuals who own shares of the company (shareholders) who are not liable for business debts or suits if they were to incur. These shareholders have significant say in the operation of the company and even elect the board of directors of the company, but, ultimately, the decisions are made by the board of directors.
Besides Limited Liability, What Are Some of the Advantages That Come With a C-Corporation?
- Perpetual Existence. Since a c corp is its own legal entity (independent of its owners), it can “live” or remain in operation indefinitely. This means that if an owner were to leave the company, it would not cease to exist.
- Ease of Transferability. Operating through a c corp makes it easy for owners to transfer their shares to others of their choosing. As aforementioned, a c corp does not stop existing if an owner leaves, so there are much fewer restrictions on how shares are owned and transferred.
- Shareholders Can Sue. A shareholder can file direct lawsuits or a derivative lawsuit. A derivative lawsuit regards the duties that the board of directors have to carry out for the corporation. Thus, if a shareholder believes that an officer from the board of directors is functioning in the best interest of the company, s/he can file a derivative lawsuit to have him/her removed.
- Lower Risk of Being Audited by the Government.
- Deduct Benefit Costs as a Business Expense. A c corp can write off the costs of health plans for employees as business expenses. These benefits are tax-free even for those receiving them.
So, What Are the Disadvantages of a C-Corporation?
- Double Tax. A c corp is taxed on two separate levels. First, it is taxed on what the c corp earns as income. Then, shareholders are taxed on any dividends issued by the corporation.
- Complicated Formalities. There is a lot of paperwork and regulations to follow as a c corp. The business must have articles of incorporation and bylaws, which detail the name of the business, its address, purpose, the name of the registered agent, how many shares of stock it will issue, appoint a board of directors, establish a general corporate strategy, and more.
- Expensive to Maintain. There are a plethora of fees that must be payed to operate a c corp, including a range of $100 to $1000 in fees to incorporate (depending on the state of incorporation), fees to prepare a corporate tax return, and more expenses.
- Many Legal Requirements. C corps have to adhere very carefully to state regulations, with each state having different regulations to follow. Furthermore, some corporations, depending on how it operates, might be required to follow federal regulations as well.
What Is A S-Corporation?
A s corp is very similar to a c corp except for three main differences:
- Ownership. While c corps have no restrictions on ownership, s corps can only have up to 100 shareholders.
- Shareholder Rights. While c corps have different strata of shareholders at the top, s corps are limited to one class of stock. This means that in c corps some shareholders’ votes count more than others as opposed to the fact that shareholders of s corps all have equal voting rights.
- Taxation. While c corps are subject to double taxation, taxation in a s corp happens at the personal level in which the shareholders report their income and losses on their personal tax return and they are only taxed at the personal income tax level.
Besides Limited Liability, What Are Some of the Advantages That Come With a S-Corporation?
- Perpetual Existence. Since a s corp is its own legal entity (independent of its owners), it can “live” or remain in operation indefinitely. This means that if an owner were to leave the company, it would not cease to exist.
- Pass-Through Taxation. As aforementioned, s corps are only taxed at the personal income tax level.
- Tax Filing Requirements. Owners of s corps can write off their business’s losses on their individual tax returns.
- Investment Opportunities. Operating as an s corp can held attract investors and growth can ensue by issuing shares of stock.
So, What Are the Disadvantages of a S-Corporation?
- Limited Ownership. S corps can only have up to 100 shareholders.
- Tax Qualifications. When filing taxes as an S corp, the Internal Revenue Service (IRS) is incredibly strict. Any mistake risks the IRS terminating S corp status and will then start taxing the company as a c corp under the “double taxation”.
- Regulation and Compliance. Like a c corp, s corps have to be incredibly diligent in complying with regulations.
All In All, Which Company Structure Should I Use For My Company?
This article merely serves as a foundational basis for this question. Evaluate the short-term and long-term goals of your company and analyze how closely they align with the potential company structures. Before finalizing your decision, it is imperative that you seek legal advice on this so that you can set your company up to realize the maximum potential and growth right at the get-go.
Disclaimer: Nothing in relation to the enclosed information should be construed and or considered as legal advice for any individual, entity, case, or situation. The following information is prepared for advertisement use only. The information is intended ONLY to be general and should not be relied upon for any specific situation. For legal advice on your specific situation, we encourage you to consult an attorney experienced in the area of Business Law.