We are back with our ABC’s of business – hopefully you didn’t miss us too much! This week the letter is L, and how could we not take that as a sign and talk about a couple of our favorite legal structures? Many business choose to putt around as a sole proprietorship, clinging onto their default structure.
However, choosing to forgo an incorporation or LLC formation may put your personal property at risk if the business does not work out. To avoid this, consider incorporating your business, or forming an LLC.
A corporation and LLC are both legal entities – that means that the business has its own debts and property, separate from your own. However, corporations can be further broken down into two different tax entities, a C-Corp and an S-Corp. The longtime standard, a C-Corp is one of the most commonly chosen types of tax entities. Creating a C-Corp allows those running the business to sell shares to raise revenue, and those with shares can collect dividends. However, C-Corps are prone to double taxation. The IRS will tax the corporation’s revenues in the form of corporate tax, and the shareholders will have to pay tax on their dividends. In order to avoid this, a business owner can choose to elect an S-Corp status
If a C-Corp qualifies by having fewer than 100 shareholders, all of whom are US citizens and are distributed profit and losses according to their interest in the business, it can elect to be taxed as an S-Corp. An S-Corp has a pass-through tax structure, meaning it does not pay any income tax. Instead, the shareholders simply report their profits and losses in their income tax returns. However, both C-Corps and S-Corps are costly to form and maintain, and are highly regulated. If the pass-through structure sounds like something worth pursuing, but you don’t want to form a Corporation and elect S-Corp status, you can form an LLC.
Limited Liability Companies
LLCs are the new kid on the block – they provide the pass through taxation benefit, do not require any annual meetings, and can be formed and run under the leadership of one person. Plus they still provide the sought after separation of personal and business debt. LLCs come with a bit of flexibility as well, as they can choose to be taxed as a Corporation if they qualify. For most this choice will make zero financial sense, but in some cases Corporate tax law might be a better fit for their needs. The drawback is in the novelty of the LLC. There is no uniform law like there is for corporations and states will vary on how they view and treat LLCs. Still, LLCs offer many of the benefits of incorporation with fewer drawbacks, and are a very popular choice for legal structure.
Now this is just the tip of the iceberg – we put out an info-graphic back in August that goes into a bit more detail, and looks at newer structures like the B-Corp. Every business, and business owner, is different, so if one of these structures sounds like something you’d like to pursue, talk it over with a professional first just to make sure its benefits are applicable to your business. But, for the most part, choosing a legal structure is an excellent step in ensuring that your future, and the future of your business, is a bit more secure.