As a society, we generally see entrepreneurs as risk-takers; however, good entrepreneurs do not take blind jumps and hope for the best. To the contrary, successful entrepreneurs are those who take calculated risks and make good decisions at the outset.
In fact, the longevity and prominence of a company begins when you choose the appropriate business model for the endeavor.
To help entrepreneurs make this decision, this post will discuss which business models exist and which one you should choose for your business.
LLC & Corporation Background
When you are ready to evolve from being a sole or general proprietorship to operating a company that is recognized by the state and constitutes its own legal business entity separate from its owner(s), you are incorporating your business.
Incorporating your business offers many benefits, depending on the structure you choose, including, but not limited to,
>tax deductions, and
>the ability to raise capital through the sale of shares in your company.
Although there are several different types of structures, the two most common are limited liability companies (LLC) and corporations.
LLC: Limited Liability Company
What is an LLC?
A limited liability company (LLC) is considered to be the least complex business structure due to its flexibility. Essentially, an LLC is a hybrid company structure that takes elements from a partnership or sole proprietorship and combines them with elements from a corporation.
An important aspect of an LLC is that it does not sell shares of stock. Rather, there is “membership interest” that expresses ownership in an LLC. Membership interest holders have voting and profit interest in the company.
Further, members of an LLC cannot be held personally liable for the company’s debts or liabilities.
What are the advantages of an LLC?
There are a number of advantages to choosing an LLC as your company structure.
Tax flexibility. For taxation purposes, the Internal Revenue Service (IRS) does not recognize an LLC as a separate entity to be taxed. Therefore, the IRS will not tax the LLC directly, and an LLC’s members will need to choose who they wish taxation to occur.
There are three types of taxation structures members of an LLC can choose from.
1. Single Member LLCs are treated as sole proprietorships. Profits and losses are taxed through the single member’s personal tax returns.
2. Partnership LLCs allow the LLC’s partners to be taxed like traditional partnerships.
3. LLCs that file as a corporation are classified by the IRS as a corporation and are taxed as such.
Remember: It is important that you outline how you wish to be taxed in your Operating Agreement so that all members and the IRS can be on the same page.
Flexibility in management. Unlike some other company structures, LLCs are not required to have a formal company structure of directors and officers.
Less paperwork. LLCs do not require some of the more stringent “red tape” procedures of other company structures. Therefore, they are easier to create and legally maintain without as much paperwork.
Enhanced credibility. In general, operating your company through an LLC will make you look more credible to partners, suppliers, and lenders.
No residency requirement. You do not have to be a U.S. citizen or legal permanent resident of the U.S. to create and operate an LLC.
What is a Corporation?
Like an LLC, a corporation is considered to be its own separate legal entity. However, one of the key differentiating elements of a corporation is that it must have a board of directors or a group of officers.
The two most common corporation types are C-Corporations and S-Corporations.
What is a C-Corporation?
A C-Corporation is one of the oldest and the most common business entity in the U.S. These corporations are owned by individuals who have shares in the company (shareholders) who are not liable for the business’s debts or lawsuits.
Corporation shareholders have a significant say in the operation of the company, even electing the corporation’s Board of Directors, although decisions are ultimately made by the Board.
What are the advantages of a C-Corporation?
There are a number of advantages to choosing a C-Corporation as your company structure.
Perpetual existence. Since a C-Corporation is its own legal entity that is independent of its owners, it can “live” or remain in operation indefinitely. Therefore, if an owner leaves the company, it does not cease to exist.
Ease of transferability. Operating through a C-Corporation makes it easy for owners to transfer their shares to others of their choosing. Since a C-Corporation does not stop existing if an owner leaves, there are fewer restrictions on how shares are owned and transferred.
Shareholders can sue. Shareholders can file direct lawsuits or derivative lawsuits. Derivative lawsuits are filed when a shareholder believes a board member or officer is not functioning in the best interest of the company and wants them to be removed.
Lower risk of being audited by the government.
Deduct benefit costs as a business expense. A C-Corporation can write-off the cost of health plans for employees as business expenses, which are tax-free for the company and employees.
What are the disadvantages of a C-Corporation?
There are a few disadvantages to a C-Corporation structure.
Double tax. C-Corporations are taxed on two levels. First, it is taxed on what the corporation earns as income. Second, shareholders are taxed on any dividends issued by the corporation.
Complicated formalities. There are a lot of regulations to follow as a C-Corporation. For example, the company is required to have articles of incorporation and bylaws, which detail, in part,
>the company name,
>the name of the registered agent,
>how many shares of stock it will issue,
>appoint a board of directors, and
>establish a general corporate strategy.
Expensive to maintain. There are a plethora of fees that a C-Corporation must keep up with. Examples of such fees include, but are not limited to,
>incorporation fees ($100-$1000 depending on the state)
>corporate tax return preparation fees
Numerous legal requirements. C-Corporations must adhere carefully to state regulations, which can vary by state. Some corporations must also adhere to federal regulations.
What is an S-Corporation?
An S-Corporation is very similar to a C-Corporation except in three ways.
1. Ownership. S-Corporations can only have up to 100 shareholders, unlike C-Corporations.
2. Shareholder rights. S-Corporation shareholders are limited to one class, meaning that all shareholders have equal voting rights.
3. Taxation. While C-Corporations are subject to double taxation, an S-Corporations are only taxed on the personal level. Therefore, shareholders are only taxed on the personal level, reporting all income and loses on their personal tax returns.
What are the advantages of an S-Corporation?
Some of the advantages of an S-Corporation include:
Perpetual existence. Like a C-Corporation, an S-Corporation is considered to be its own legal entity. That means it is independent of its owners and will continue to exist if an owner chooses to leave.
Pass-through taxation. Again, S-Corporations are only taxed at the personal income level.
Tax filing requirements. S-Corporation owners can write off their business loses on their individual tax returns.
Investment opportunities. S-Corporations provide the ability to grow through the issuing of shares of stock.
What are the disadvantages of an S-Corporation?
There are a few disadvantages of the S-Corporation structure.
Limited ownership. S-Corporations can only have up to 100 shareholders.
Tax qualifications. When filing taxes as an S-Corporation, the IRS is incredibly strict. Any mistake risks the IRS terminating the S-Corporation status and taxing the company as a C-Corporation under “double taxation.”
Regulation and compliance. As with C-Corporations, S-Corporations must be extremely diligent in complying with regulations.
Which company structure should I use for my company?
The final decision on which structure is best for you and your company is up to you and your goals.
Evaluate the short-term and long-term goals of your company and then compare how they align with the potential company structures.
It is also good practice to seek legal advice before finalizing your decision, so that you can set your company up to realize its maximum potential and grow from the outset.
Note: This article is co-authored by Sawsan Selim. This post was originally published on 12/22/17 and has been updated as of 12/17/19.
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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 Immigration Law.