Can’t Decide Between Business Entities? Here’s How to Choose
- June 22, 2020
- Starting Your Business
- 9 min read
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One of the first big decisions to make as an entrepreneur is what business entity to choose. If you’re not familiar with the various business entities, this can be confusing. So let’s go over the major types of business entities then figure out which may be ideal for your business.
Limited Liability Company (LLC)
LLC is the most popular business entity right now. MyCompanyWorks, which helps businesses form legal business entities, estimates that about 75% of its customers choose this entity now and that number is rising. Why? The LLC is a very simple structure yet still provides the all-important liability protection of a corporation. This means that while your LLC can be sued, a properly-structured LLC can protect your personal assets like investments, houses, cars and other assets from being subject to legal judgment.
Another reason is the structure of an LLC itself is very simple. Unlike a corporation, there are not multiple levels of management (shareholders, directors, officers). A basic LLC is simply “member-managed,” which means the owners make all the decisions which can be voted on if necessary (weighted by each owners membership percentage) so you don’t have the complicated approval process, meeting and minutes required by a corporation.
An LLC can be taxed like a simple sole-proprietorship or partnership meaning you just add any income onto your personal tax return. If you set up a simple member-managed LLC you also don’t have to worry about processing payroll for yourself (like you would for a corporation). Even better, if you want to be taxed like an S corporation (see below), you can file form 8832 with the IRS and have your LLC taxed as an S corporation.
Finally, an LLC is very flexible in who can own it and whom it can be owned by. For example, an S corporation can only be owned by U.S. citizens (or green card holders) and cannot own or be owned by other companies. The LLC has no such restrictions and can be owned by foreigners, other companies, can own other companies and in fact is now the preferred entity for “holding companies” both large and small. A C corporation also has this flexibility but has a more complex structure (see below).
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When to Choose the LLC
If any of the below statements seem familiar, then an LLC could be the right entity for your business:
- If you like simplicity of structure, taxation and operation the LLC is likely the entity for you.
- If you want an S corporation for tax reasons but don’t want to bother with corporate stock or structure.
- If you need foreign shareholders for your company, to own (or be owned by) other entities, but don’t want the complexity of a C corporation.
A C corporation is just a normal corporation, it’s the default status when you create a corporation. Like the LLC, it can own and be owned by foreigners and other companies.
Unlike an LLC, the C corporation has stock and the standard corporate structure of shareholders, directors and officers. This makes it more complex to run and make decisions (even if you hold all roles, you still need to document your decisions in written minutes).
Taxation is currently at a historical low of 21% of profits but much more complicated to prepare, requiring a completely separate tax return and careful accounting of shares and dividends for each shareholder (which is not limited in number like the S-Corporation). Note that you will pay the 21% tax on the profits and then pay it again when you give the profits to each shareholder as dividends (who will then pay their personal tax rate on those dividends). This is known as double-taxation and one of the reasons people choose the LLC or S-Corporation so often.
These days, the C-Corporation is not very popular for smaller companies unless you absolutely need the structure. Venture capitalists, angel investors and more may require a C-Corporation (and specifically a Delaware corporation) before they will invest due to the nature of Delaware’s corporation legal code. However, there is the flexibility of ownership and the lower tax rate so it definitely has its fans. Almost every large company in America from GE to Microsoft is a C-Corporation.
When to Choose the C Corporation
A C corporation might be right for you business if:
- If your investors require it or you need the advanced structure (for international owners or holding company purposes).
- If you are willing to do more work to get the lower corporate tax rate or otherwise need this structure.
An S corporation is not a different type of corporation, just a different status with the IRS. “S” simply means small. To elect S corporation status you need to have less than 100 shareholders, they must be U.S. citizens (or green card holders) and the company cannot own or be owned by other entities. To make the election you file form 2553 with the IRS. Some states require their own form, too.
The benefit of the S corporation is that it has no corporate income tax at all — the profits are distributed to each individual owner and they each pay their individual tax rate. This is a very big tax break in most cases and why the S corporation was created in the first place.
Remember though, you still have the more complex structure of a C corporation and relatively complicated taxation (S corporations typically require an accountant to prepare the tax forms).
When to Choose the S Corporation
You may want to choose an S Corporation if:
- If you want big tax savings but don’t mind the complexities of the corporate structure (levels of management and taxation mostly).
- If you need corporate stock (instead of having your LLC taxed as an S corporation).
The Bottom Line
If you like simplicity, the LLC may be right for you. If you need investors it will probably need to be a C corporation. If you like to save taxes, then the S corporation may be right for you (or an LLC taxed as an S corporation if you don’t need the stock or corporate complexity).
More From Seek
- What Is an LLP?
- S-Corp vs. C-Corp: What’s the Difference?
- How to Get a Business License
- 10 Incorporation Documents You Need to Make Your Business Official
Photo credit: GaudiLab/Shutterstock.com
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