Thinking about starting a new business? Let’s pause for a minute and weigh some important considerations before you start the hiring process or sign that commercial lease. First, protect yourself by setting up an entity. In the unfortunate event that a lawsuit is brought against your business, a company that is properly set-up and well-maintained can help keep you from being held personally liable.
Now, what type of company suits you? There are three common choices: “C Corporations,” “S Corporations,” and, a favorite among lawyers, “Limited Liability Companies” (LLCs). Each organizational form has its advantages and disadvantages, and owners should consider how these differences apply to their specific situation.
Before choosing an entity type, ask yourself these two questions:
1. How high of a priority is reducing my taxes?
C Corporations are subject to what is called “double-taxation.” First, C Corporations pay taxes on all profits that are not considered business expenses. Second, if the corporation distributes dividends to its shareholders, the shareholders are then required to pay taxes on those dividends. In the end, the same income is being taxed twice, which may be unattractive to some business owners.
S Corporations and LLCs, on the other hand, are “pass-through” or “flow-through” entities. This means that money flows through the entity to the owners. In other words, the owners are taxed and the entity is not, which avoids double-taxation for the owners. Although both S Corporations and LLCs are pass-through entities, S Corporations must file a business tax return, while LLCs only file a business tax return if there is more than one owner.
S Corporations can also be advantageous for self-employment. S Corporation owners can be considered employees and be paid a “reasonable salary.” After this salary is paid, corporate earnings can be treated as unearned income that will not be subject to self-employment taxes.
There is also an additional option for some businesses: eligible LLCs can elect to be taxed like an S Corporation. Here are the eligibility requirements for that “S” status:
- 1. the company has fewer than 100 owners;
- 2. all owners are US citizens or permanent residents;
- 3. the company only offers one class of ownership; and
- 4. no owners are corporations or other partnerships.
2. How much capital do I need to sufficiently fund my business, and what kind of investors or owners will there be?
Of all the entities, C Corporations grant the most flexibility in raising funds. C Corporations can raise capital by issuing a potentially unlimited amount of shares to an unlimited number of investors. That’s because C Corporations have the unique ability to “go public.” If you’re planning on growing your company and taking its shares to be publicly traded on the stock exchange, then a C Corporation may be the right choice.
LLCs are more flexible than C Corporations, but LLCs can’t go public. If you’re looking to keep your company privately-owned and raise money, which may include foreign investors, or have other entities as shareholders, an LLC could be the best option.
Remember to check in with your legal team and accountants to make sure your business is structured correctly.
This Blog is made available by Romano Law PLLC for general informational and educational purposes only, not to provide specific legal advice. By using this Blog you understand that there is no attorney client relationship between you and Romano Law PLLC or any individual contributor. You should consult a licensed professional attorney for individual advice regarding your own situation.