This owner wants to avoid all, but a minimum of corporate paperwork does not project a need for extensive outside investment and does not plan on taking her company public and selling the stock. In general, the smaller, simpler, and more personally managed the business is, the more appropriate the LLC structure would be for the owner.
If your business is larger and more complex, an S corporation structure would likely be more appropriate. It depends on how the business is established for tax purposes and how much profit is going to be generated. Both an LLC and S corp can be taxed at the personal income tax level. S corporation owners must be paid a salary in which they pay Social Security and Medicare taxes.
However, dividend income or some of the remaining profits after the owner's salary has been paid can be passed through to the owner, but not as an employee, meaning they won't pay Social Security and Medicare taxes on those funds.
An S corporation provides limited liability protection so that personal assets cannot be taken to satisfy business debts by creditors. S corporations also can help the owner save money on corporate taxes since it allows the owner to report the income that's passed through the business to the owner to be taxed at the personal income tax rate. If there will be multiple people involved in running the company, an S corp would be better than an LLC since there would be oversight via the board of directors.
Also, members can be employees, and an S corp allows the members to receive cash dividends from company profits, which can be a great employee perk. If you're a sole proprietor, it might be best to establish an LLC since your business assets are separated from your personal assets. You can always change the structure later or create a new company that's an S corporation.
An S corporation would be better for more complex companies with many people involved since there needs to be a board of directors, a maximum of shareholders, and more regulatory requirements. LLCs are easier and less expensive to set up and simpler to maintain and remain compliant with the applicable business laws since there are less stringent operational regulations and reporting requirements. Nonetheless, the S corporation format is preferable if the business is seeking substantial outside financing or if it will eventually issue common stock.
It is, of course, possible to change the structure of a business if the nature of the business changes to require it, but doing so often might involve incurring a tax penalty of one kind or another. Therefore, it is best if the business owner can determine the most appropriate business entity choice when first establishing the business. In addition to the basic legal requirements for various types of business entities that are generally codified at the federal level, there are variations between state laws regarding incorporation.
Therefore, it is generally considered a good idea to consult with a corporate lawyer or accountant to make an informed decision regarding what type of business entity is best suited for your specific business. Internal Revenue Service. Chronicle of Small Business. Digital Media Law Project. How To Start A Business. Small Business Taxes. Business Essentials. Your Privacy Rights. To change or withdraw your consent choices for Investopedia.
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Your Money. Personal Finance. Your Practice. Popular Courses. Business Essentials Guide to Mergers and Acquisitions. Business Business Essentials. Table of Contents Expand. LLC vs. S Corporation: An Overview. S Corporations. Special Considerations. S Corp FAQs. The Bottom Line. S Corporation: An Overview Choosing the right business structure is crucial to the success of your business.
Key Takeaways An LLC is a limited liability company, which is a type of legal entity that can be used when forming a business. Pros Personal liability protection No double taxation Easier to establish and operate than a corporation Flexible structure.
Cons More costly to establish than a sole proprietorship or partnership Must file an annual report, and the fee can cost hundreds of dollars Cannot attract outside investment other than banks. With that, partnerships are liable for any lawsuits and judgments against the company. General partnerships are agreements between two or more individuals in pursuit of profit, and there are no fees associated with creation of the organization. General partnerships allow for more support and creative decision making.
Each member absorbs all profits and liabilities for the business, and each one contributes something in the form of labor, skill or financial resources to the venture. Owners can also report any net businesses losses on their income taxes. General partners can also raise money without giving up a portion of their control in the business. Limited partnerships provide limited personal liability against any debts absorbed on the amount of money they put into the organization.
LPs attract many investors because they are only responsible for their portion of the business. Each partner must file with state authorities to be granted limited status. Limited partners can also exit the organization with no need to dissolve the partnership itself.
Sole proprietorships are the simplest business structure, and it can be dissolved with the most ease. Sole-proprietors are also known as consultants, freelancers or independent contractors. This is a business run by one individual for his or her own benefit. This form of ownership is operated by a lone individual for his or her own gain and does not exist outside of the owner. Both partnership forms create a legal entity for the business where interest can be transferred to other parties.
A general partnership will be quicker and easier to establish as it requires less form filling. Also, like sole proprietors, the partners remain liable for business activities and debt. Limited partnerships, on the other hand, are made up of general partners and limited partners. With limited partnerships, written agreements must be signed, and certificates should be filed with the relevant authorities.
This will protect you in the future and ensure that the partnership is fair. A corporation is a complete legal entity, separate from its owners with Articles of Corporation having to be filed with the state.
The drawbacks are that double taxation will occur; first on the profits of the business and then on dividends paid on shares or earnings you draw from the company. An S-Corporation is a slight variation to the corporation structure. There will also be limits on who can own the shares, which may restrict your fundraising capabilities. Using the corporate structure is more complex and expensive than most other business structures. A corporation is an independent legal entity, separate from its owners, and as such, it requires complying with more regulations and tax requirements.
The biggest benefit for a small-business owner who decides to incorporate is the liability protection he or she receives. A corporation's debt is not considered that of its owners, so if you organize your business as a corporation, you're not putting your personal assets at risk. A corporation also can retain some of its profits, without the owner paying tax on them.
Another plus is the ability of a corporation to raise money. A corporation can sell stock, either common or preferred, to raise funds. Corporations also continue indefinitely, even if one of the shareholders dies, sells the shares or becomes disabled.
The corporate structure, however, comes with a number of downsides. A major one is higher costs. Corporations are formed under the laws of each state with their own set of regulations. You'll probably need the assistance of an attorney to guide you through the maze. In addition, because a corporation must follow more complex rules and regulations than a partnership or sole proprietorship, it requires more accounting and tax preparation services. Another drawback: Owners of the corporation pay a double tax on the business's earnings.
Not only are corporations subject to corporate income tax at both the federal and state levels, but any earnings distributed to shareholders in the form of dividends are taxed at individual tax rates on their personal income tax returns. To avoid double taxation, you could pay the money out as salaries to you and any other corporate shareholders.
A corporation is not required to pay tax on earnings paid as reasonable compensation, and it can deduct the payments as a business expense. Keep in mind, however, that the IRS has limits on what it believes to be reasonable compensation. How to Incorporate To start the process of incorporating, contact the secretary of state or the state office that is responsible for registering corporations in your state. Ask for instructions, forms and fee schedules on business incorporation.
It's possible to file for incorporation without the help of an attorney by using books and software to guide you along.
Your expense will be the cost of these resources, the filing fees, and any other costs associated with incorporating in your state. The disadvantage of going this route is that the process may take you some time to accomplish.
There's also a chance you could miss some small but important detail in your state's law. One of the first steps you must take in the incorporation process is to prepare a certificate or articles of incorporation. Some states will provide you with a printed form for this, which either you or your attorney can complete.
The information requested includes the proposed name of the corporation, the purpose of the corporation, the names and addresses of the parties incorporating, and the location of the principal office of the corporation. The corporation will also need a set of bylaws that describe in greater detail than the articles how the corporation will run, including the responsibilities of the shareholders, directors and officers; when stockholder meetings will be held; and other details important to running the company.
Once your articles of incorporation are accepted, the secretary of state's office will send you a certificate of incorporation. Once you're incorporated, be sure to follow the rules of incorporation.
If you don't, a court can pierce the corporate veil and hold you and the other owners personally liable for the business's debts. It's important to follow all the corporation rules required by state law. You should keep accurate financial records for the corporation, showing a separation between the corporation's income and expenses and that of the owners'. The corporation should also issue stock, file annual reports and hold yearly meetings to elect officers and directors, even if they're the same people as the shareholders.
Be sure to keep minutes of these meetings. On all references to your business, make certain to identify it as a corporation, using Inc. You also want to make sure that whomever you deal with, such as your banker or clients, knows that you're an officer of a corporation. The S corporation is more attractive to small-business owners than a standard or C corporation.
That's because an S corporation has some appealing tax benefits and still provides business owners with the liability protection of a corporation. With an S corporation, income and losses are passed through to shareholders and included on their individual tax returns. As a result, there's just one level of federal tax to pay. In addition, owners of S corporations who don't have inventory can use the cash method of accounting, which is simpler than the accrual method.
Under this method, income is taxable when received and expenses are deductible when paid. Some relatively recent tax law changes brought about by the Small Business Job Protection Act of have made S corporations even more attractive for small-business owners. In the past, S corporations were limited to 35 shareholders. The law increased the number of shareholders to Expanding the shareholder number makes it possible to have more investors and thus attract more capital, tax experts maintain.
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