As a business owner, you can benefit in various ways by setting up your company as an LLC, an S corporation, or a C corporation. Instead of remaining sole-owner or a partner, you can format your business into a corporation; by doing so, you create a whole new legal entity for your business. The business is now separate from you as a person, and can function as its own “person” through contracts, taxes, financial matters, and lawsuits.
Incorporating can bring great benefits. Consider the following:
- Protection. As a corporation, you have protection for your business liabilities.
- Endurance. Your unique business name will remain “forever” once you incorporate, and no other can file with that name in your state. Further, your corporation will continue on even if management and ownership changes hands. Should you remain unincorporated, a change in leadership could change the entire status of your business.
- Perception. People perceive businesses that include an “Inc.” or an “LLC” in their titles differently; the classification carries some authority, and it commands respect.
- Tax Benefits. Your tax benefits and flexibility can improve when you incorporate; you can take advantage of more legal tax deductions by incorporating.
- Raise funds. If you are planning to raise capital for your small business, you can do so much more easily if you are incorporated; being incorporated allows you to sell stock and securities to investors.
Of course, there can be some disadvantages to incorporating.
- Some small business owners detest the increase in paperwork. Should you incorporate, at a minimum you will file a tax return for your business and a tax return for your personal finances—both requiring detailed records.
- There is an expense associated with incorporating your small business, which can be a burden. LLCs are typically the least expensive choice for incorporation.
LLC, S Corp, or a C Corp?
What is an LLC?
LLC stands for a “limited liability company,” and is somewhat of a “new kid on the block” in the United States.
Limited liability. Owners carry limited liability for the company’s debts, and no one partner is ultimately responsible for the debts.
Profits and losses remain. The company’s profits and losses remain with the owners, as in a partnership. And, owners of an LLC can distribute profits as they wish and to whom they choose.
Flexibility. Business owners find ultimate flexibility in being an LLC. There are no restrictions on ownership responsibilities or numbers of owners with an LLC; owners of the company can run the business or delegate responsibilities to outsiders also.
Self-employed. An owner of an LLC is considered “self-employed” and pays self-employment tax each year based on the net profits of the business towards Medicare and social security. By April 15th each year, a 1040, a Schedule C, and a 1065 will be filed (1065 only if there are partners in the LLC).
How to Incorporate into an LLC. File an “Articles of Organization “ document with your state.
S Corporations resemble LLCs because their profits remain with the owners and are included in the owner’s personal tax returns each year. However, they are not nearly as flexible as an LLC. For example:
- S corporations can only have seventy-five shareholders.
- Shareholders must all be residents of the U.S.
- S corporations carry strict procedures for record keeping, ownership, management, and profit distribution.
- S Corps require that the profits be distributed strictly according to stock ownership ratios (regardless of how the owners view the year and individuals’ efforts in making the business successful).
- Profits passed on to shareholders are taxed as “personal income” according to subchapter S in the IRS code.
- You can incorporate into an S Corporation if your business’s shares are held by U.S. citizens or by qualified trusts.
Keep in mind: while the tax savings are attractive, it does come with extra paperwork that can be overwhelming. You will not simply pay taxes on April 15th, but instead you will have deadlines throughout the year that you must meet. Should you lose track of the deadlines or have a cash-flow problem, you may find yourself uncomfortably “behind the eight ball” with the IRS; and that is never a comfortable place to be.
By definition, a C corporation is a business/corporation that is taxed apart from its owners because the business is truly a separate entity. It is attractive to some owners because of the limited liability that it offers.
- Ownership flexibility. While C Corporations have more qualifying rules than LLCs, they are less limited than S corporations in terms of ownership. C Corps can have foreign or domestic owners/shareholders and an unlimited number as well.
- Taxes. C Corporation profits are taxed apart from its owners (not as personal income) according to subchapter C of the IRS code. Further, a great many tax benefits and deductions are available to C Corps. Your accountant can help you take advantage of those.
- Owned by shareholder. The shareholders appoint a board of directors to guide and direct business and policy.
- C Corps stand alone. Regardless of changes in owners and shareholders, a C Corporation will continue; it is its own entity.
- Financial reports. As a C Corporation, you may be required to report your financial status to your state’s attorney general.
- Limited liability. As part of a C Corporation, you will not be personally liable for debts, lawsuits, or any other troubles the corporation may incur.
- Fewer audits. LLCs, sole proprietors, and partnerships are generally audited more often by the IRS than are C Corps.
In order to be considered a C Corporation, you must:
- Have a healthy amount of money (capital) invested in the company.
- Conduct consistent meetings with your board of directors and your shareholders.
- Issue formal stocks to your initial shareholders.
- Keep records of all things related to your business separate from the financial records of the owners.
While C Corps offer limited liability (protecting your personal assets), you may find yourself liable in some rare circumstances still, such as:
- If you are personally responsible for injuring someone.
- If you guaranteed a loan personally, but the corporation then could not pay.
- If you are responsible (personally) for any illegal behaviors within the corporation.
- If you misfile your taxes intentionally.
If the rules and formalities are not followed, a court can order the “end” of a corporation; if this were to happen, then you would most likely become liable for wrongdoings.
Clearly, you have some options to consider. Talk them over with your trusted financial and legal advisor and move in a wise direction towards success.
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*This article is not a substitute for legal advice or a tax professional.