Best Entity Structure for Your New Business

Should You Use a C Corp, S Corp or LLC for Your Business Startup?

A big decision you must make in starting your new business is the type of entity structure to use. Should you incorporate as a C Corporation or an S Corp, or should you use an LLC (a limited liability company)?

Before you make the final decision, you should consult a tax professional as well as an attorney. The attorney will explain the legal ramifications of each structure and the tax professional can discuss the tax advantages and disadvantages for each structure.

What is best for you will depend on your own circumstances.

Below is a quick overview.

Basics of Forming a C Corporation
Basics: A C Corp is a legal entity owned by shareholders. You establish a C Corp by filing incorporation documents with a state and paying any filing fees required. This structure limits each shareholder’s personal liability to the amount the individual invested in the company.

C Corp Advantages
• Good structure for raising capital (you can sell shares)
• Offers profit-sharing options for owners
• Enables keeping earnings in the business to use for growth
• Provides financial flexibility for distributing earnings, establishing salaries, fringe benefits, etc.
• Makes it easier to sell the business
• Allows you to offer stock-options to employees
• Protects shareholders from any liabilities incurred by the corporation

C Corp Disadvantages
• The IRS double taxes the profits. The corporation pays taxes when it earns revenue and shareholders pay taxes on the dividends they receive from the corp.
• Any capital gain incurred by selling or liquidating corporate assets are also double taxed (there are some exceptions).
• Shareholders cannot deduct any corporate losses
• Only accrual accounting is allowed (there are some gray areas with this issue)
• Less flexibility (compared to other entities) in special allocation of profits or expense items.
• More costly to set-up and maintain (compared to a sole proprietorship or an LLC)

Basics of Forming an S Corporation
Basics: An S Corporation must also incorporate by filing documents with a state and filing the appropriate filing fees. In those filing documents, the filers elect the special S filing status with the IRS. Only U.S. Companies can elect to file as an S Corporation.

S Corp Advantages
• No double taxation. The corporation passes all profits (or losses) through to the shareholders. Each shareholder reports the profits/losses on his/her tax return.
• Offers more flexibility in your accounting (you can elect to use a cash or accrual method)
• Enables flexibility in salary and dividend payments
• Protects shareholders from any liabilities incurred by the corporation

S Corp Disadvantages
• Poor structure for raising money from a large number of investors (limits shareholders to 100)
• Only one-class of stock allowed
• Company must distribute profits to shareholders in a proportionate manner (a 10% owner must get 10% of the distribution)
• Owners (shareholders) must be US citizens
• Shareholders must pay themselves a “reasonable salary”
• More costly to set-up and maintain (compared to a sole proprietorship or an LLC)

Basics of Forming a Limited Liability (LLC) Company
Basics: This structure combines limited liability protection of a corporation and the pass-through taxation of a partnership. An LLC is legal structure through which an individual or group of individuals own assets or an enterprise.

To form an LLC, you file incorporation papers with your state.

LLC Advantages
• Streamlined tax filing as the owners can report their business activity on their personal tax return.
• Less expensive and easier to setup
• No limits on the number of members
• Limits losses to amount invested (protects personal assets from corporate liability)
• Enables you to pass through losses to owners
• Possible for the LLC to own real estate, which is not advisable for C or S Corporations

LLC Disadvantages
• Must pay self-employment taxes and typically make quarterly estimates
• Careful record keeping required. You must be careful to keep personal and business expenses and income separate from personal or you risk “piercing the corporate veil” and losing liability protection.
• To file with the IRS you need at least two owners (you can file as a single-member LLC with the state).
• Can be dissolved with the death or bankruptcy of a member

Which is right for you? Call us and we would be happy to discuss your situation.

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