A straight S corp or C corp are considered solid from a liability perspective as well. Going back to the fictitious companies introduced at the beginning, which entity type should they choose? As a classic technology startup hoping to receive VC or PE funding, they have little option but to be a C corporation.
The only other possible consideration would be to form first as an LLC taxed as a partnership or S corporation then cut over to C status when the corporate investors become a reality. This structure would be simpler early on and potentially allow the early investors to deduct losses on their personal tax returns. Next year they will draw wages from the S corporation and the remaining profits will not be subject to FICA.
As a young entrepreneur with a short-term business plan, Joe is a perfect candidate for a sole proprietorship. An S corporation would require significant cost to set up, and he would have to pay himself a reasonable wage subject to FICA. Plus the hassle of running payroll would not be worth it. An LLC umbrella would add liability protection if Joe felt he needed that.
Plus, partnerships allow profits to be disproportionately distributed to owners, which is a goal of this group. There are no non-owner employees, which means no payroll would be required if the entity were a partnership. I mentioned at the beginning that this guide would make some high-level general recommendations that entrepreneurs like to have.
I still intend to do that. Keep in mind these statements are general comments for general situations. This article is only intended to be a general guide to familiarize business owners with the available options and point them in the right direction. If you are on the cusp of choosing an entity type, reach out to your tax advisor or someone at Toptal for direction on your specific situation.
It is too big of a decision to get wrong. The major difference is how they are taxed. S Corp income flows to stockholders and is taxed on their personal tax returns. Dividends paid to S Corp stockholders are not taxable. C Corps pay income tax on their corporate tax return. Stockholders must generally pay income tax on any dividends they receive.
Many privately held companies are organized as S Corps so the owners can avoid the double taxation of C Corps. However, S Corps have strict stockholder eligibility rules, which makes the C Corp structure more attractive to large companies that are seeking institutional or foreign investors.
An owner of a sole proprietorship can be held personally liable for debts and judgments against the proprietorship. That is a bit of a misguided question. Subscription implies consent to our privacy policy. Thank you! Check out your inbox to confirm your invite. Finance All Blogs Icon Chevron. Filter by. View all results.
Finance Processes. Author Scott Hoover. Scott is a CPA with three focus areas: high-level monthly financial oversight, accounting software projects, and corporate tax planning. The venture is early-stage and looking for private equity investors. The goal is to be on the market within a year and be a relevant player within three years, with several capital infusions along the way.
What entity type should FreeBooks choose? They are leaning toward forming an S corporation, but the other options sound attractive too. What entity type is best? Joe is an year-old looking for summer income. He has decided to start a small lawn care business.
He will have no employees. What entity type should he choose? Jill, Ben, and Dorcas are siblings who own equal percentages of an apartment complex.
Jill is a silent investor, while Ben and Dorcas manage and maintain the property. Jill is fine if she does not receive her full share of the profits because she is contributing nothing but capital to the project.
JBD Group is wondering what entity type they should choose? This list would be better organized into categories, as follows: Pass-Through Entities: Sole proprietorship Partnership S Corporation C Corporation LLC, which is a legal entity only, and is taxed as one of the four options above The reasons for this more nuanced breakdown will become clearer as we go through the guide.
At a very high level, the choice of entity comes down to a few key considerations: How profits are taxed. Complexity and cost of setting up the entity, as well as ongoing governance and administration. Sole Proprietorships Sole proprietorships are by far the simplest business structure. Partnerships A partnership is like a multi-owner version of a sole proprietorship. S Corporations As companies become more complex and profitable, partnerships and proprietorships tend to be less suitable.
For example: You must generally be a person and a US resident or citizen to own an interest in an S corporation. That is a deal breaker for companies seeking corporate or foreign investors e.
Certain trusts and estates are allowed as stockholders, but partnerships and corporations may not own a stake in an S corporation. Profits and distributions must always be allocated according to ownership. There is no flexibility. Loss utilization can be limited. In some cases, an owner of an S corporation that has losses may not be able to deduct that loss on their personal tax return.
The loss would be carried forward to a future year, but most startups would appreciate the extra cash from a tax refund today, not in some future year.
A partnership or proprietorship structure is generally more favorable to claiming such losses. Only one class of stock is allowed. There can be voting and non-voting shares but that is it. Classes of preferred and common stock are not allowed. There can be a maximum of stockholders. Although both options provide you with limited liability protection, there are some differences between each structure to consider. The biggest difference between these two entities is that a single-member LLC has one owner, whereas two or more people will own a multi-member LLC.
Imagine that you own a media consulting firm and have hired several employees, including an account manager. While multiple people work in your business, it would still be a single-member LLC, since you are the only owner. If you are establishing a multi-member LLC, you will need to draft an operating agreement for your company. In addition to outlining ownership percentages, your operating agreement will describe whether a professional manager will run your company or if your LLC will be member-managed.
An LLC that is member-managed is operated by its owners. When it comes to simplicity, there's almost no better choice than a member-managed LLC. If you choose this management structure, all owners will have the ability to make business decisions and handle important tasks, including:. If you form an LLC with one of your friends, and you both decide to participate in the day-to-day operations of your company, your business would be a member-managed LLC. When you hear the words foreign or domestic used to describe an LLC, they are describing the location where the LLC was established and operates.
Be aware, however, that these terms only apply to the state level, as LLCs are not formed at the federal level. Forming a foreign LLC is a common choice for companies whose home state does not possess business-friendly laws. Some states offer LLCs more beneficial tax rates and cost-effective formation options, and establishing an LLC in one of these states can be very advantageous. You should understand that just because you sell to customers or work with a client in a different state, it doesn't mean you need to register your company as a foreign LLC.
Generally, you need to have a physical business location in that state before foreign limited liability company registration is required. If you file a doing business as DBA , your company can do business using a name other than your legal name. A DBA is also commonly called a fictitious name or an assumed name. In most cases, you will file your DBA in the county where your business is located and operates.
Certain states also allow you to file a DBA at the state level. If you are forming a general partnership or a sole proprietorship, the name of your business will be your legal name unless you file a DBA. General partnerships and sole proprietorships can benefit greatly from registering as a DBA. For instance, with a DBA filing, you will not need to follow the same regulations needed to establish a limited liability. Understand, however, that a DBA registration will not change the legal name of your company.
If you want to establish a limited liability company or a corporation, you need to file the appropriate documents with your state. For a corporation, you would need to complete and submit Articles of Incorporation. LLCs are required to file Articles of Organization. The benefit of incorporating your business is that it shields you from personal liability.
Unlike the owners of partnerships and sole proprietorships, your personal assets will be protected from business obligations if you incorporate. Before you can incorporate your business, it's important to research the different structures from which you can choose.
A traditional C corporation , for example, legally separates you, the owner, from your business. Your C corporation will be formed at the state level, and once established, you cannot be held personally liable for the debts of your business. Limited liability companies are also formed at the state level. An LLC will provide you with the same personal protections as a corporation, but they will be considerably easier and more affordable to incorporate.
If you own a small business, forming an LLC or an S corporation is typically the best choice. The benefit of forming a C or S corporation is that expanding your business will be much easier. Because LLCs are usually pass-through entities, their owners can qualify for the special pass-through tax deduction created by the Tax Cuts and Jobs Act. This deduction took effect in and is scheduled to continue through An LLC is the simplest business entity to form and operate.
Unlike with a corporation, it is not necessary to have officers and directors, board or shareholder meetings, or the other administrative burdens that come with having a corporation. LLCs provide enormous flexibility when it comes to ownership, management, and taxation.
There are no minimum or maximum limits on the number of owners--also called members--that an LLC can have. LLCs can be managed by their members--that is, all the owners share responsibility for the day-to-day running of the business. LLCs also have the option of designating one or more managers to run the business. The managers can be designated members, nonmembers, or a combination of both. LLCs can also choose how they want to be taxed. They are usually taxed as sole proprietorships or partnerships, but SMLLCs and multi-member LLCs have the option of choosing to be taxed like a corporation.
This is easily accomplished by filing a document called an election with the IRS. LLCs can choose to be taxed as a C corporation or an S corporation. Either way, the LLC owners ordinarily work as employees of the corporations. With C corporation taxation, the corporation pays taxes on the business profits at the corporate tax rate. With S corporation treatment, the LLC remains a pass-through entity, with profits passed through the business to the owners to be taxed at their individual tax rates.
But such distributions are not subject to Social Security and Medicare taxes. Thus, S corporation tax treatment can result in tax savings. Forming an LLC to own and run your business helps give you credibility. It reassures customers that yours is a real business. You'll also have an official business name to use. To learn more, see " Advantages of an LLC ". Cost : It generally costs more to form and operate an LLC than to be a sole proprietor or have a partnership.
Filing fees must be paid to legally establish the LLC. Once the LLC is formed, annual fees and taxes will have to be paid to the state.
Investment Disadvantages : LLCs are not ideal for business owners who seek outside investors. This is particularly true if you're looking for funding from venture capitalists, who ordinarily will only fund corporations.
Corporations work best for outside investments because stock can be issued in exchange for investors' money. Outside investors can invest in LLCs and receive LLC ownership interests, but this can be more complicated than with a corporation.
Starting an LLC is relatively easy. You file articles of organization or a similar document with your secretary of state's office and then take some additional steps to get your LLC up and running. Each state has its own unique LLC formation requirements. To learn about the specific requirements of forming an LLC in your state, choose your state from the list below:. The cost varies from state-to-state.
Most of the cost is the fee to file your articles of organization. It will cost much more if you hire a lawyer. The default tax regime is for LLCs with a single member to be taxed as sole proprietorships, while LLCs with multiple members are taxed like partnerships.
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