BUSINESS FORMATIONS – WHICH IS BEST?

ENTITY CHOICES

Business Formations – Which is best?

Forming a Limited Liability Company or Corporation provides a wonderful liability protection that benefits the individual owner and the small business.   Spending just a small amount of money up front and keeping your records up to date can make all the difference towards success.  One question business owners frequently ask is which legal structure is right for their business.  So which is best for you?

Sole Proprietorships and Partnerships

Operating your business as a sole proprietorship or partnership is a great beginning to allow time to establish your business, but you need to be aware that you will have unlimited liability for business debts. In other words, if your business is sued for any reason, the plaintiff will be able to come after your personal assets, not just business assets. Once the business is flowing, it is smart to consider an entity formation that can provide liability protection by having the business stand on its own, separate from the business owner’s personal assets.

Limited Liability Company

For some businesses, a Limited Liability Company (LLC) is the best structure. These businesses tend to be small to medium sized and have decided that they won’t want to go public and offer stocks. Limited Liability Company’s share many of the same qualities as an S-Corp or C-Corp while enjoying more flexibility and requiring less paperwork. Single-owner LLCs are taxed just like sole proprietorships, and multiple-owner LLCs are taxed just like partnerships. Payment to LLC members are received as owner draw and reported on Form K1 tax report. LLCs are best for someone who is a Sole Proprietor or Partnership, without payroll, but wants the liability protection.  Real Estate Investors and Service Based Business are the typically preferred situation for an LLC choice.

Corporations

There are two types of corporations; C-Corporation and S-Corporation.  Knowing the similarities and differences can help the business owner to choose the one that would best suit the business.

The Similarities    The following traits are common to both C-Corps and S-Corps:

  • Liability Protection: Shareholders in both C-Corps and S-Corps are generally not responsible for business debts or business liability. Liability protection can be sacrificed if the company does not remain compliant.
  • Corporate Structure: Corporations must have a structure that breaks down into shareholders, directors and officers.
    • Shareholders own the company. They elect the board of directors. Shareholders receive payment as Corporate Dividends. C-Corp dividends report on form 1099 and S-Corp shareholder distributions report appear on Form K1
    • Directors oversee larger issues, such as corporate goals, affairs, and decision-making. They elect officers
    • Officers deal with day-to-day business affairs. Directors and Officers can be the same person/people. Corporations have a payroll requirement for officers. Payment and withholdings are reported on the annual Form W2.
  • Corporate Documents and Compliance: Both C-Corps and S-Corps need to file certain documents with the governing entity in their state. Typically, these are the Articles of Incorporation to form the entity and annual Statement of Information filed with the Secretary of State. Corporations have obligations such as issuing stock, paying fees, adopting and enacting bylaws, and holding shareholder and director meetings (as well taking meeting minutes at these meetings).

The Differences    The main differences between an C-Corp and S-Corp fall into three categories: ownership, shareholder rights, and taxation.

  • Ownership: C-Corps allow unlimited amounts of shareholders and thus are a great choice for larger businesses. S-Corps may have no more than 100 shareholders and these shareholders must all be resident aliens or citizens of the United States. While C-Corps can be owned by other corporations, LLCs, or Trusts; S-Corps cannot.
  • Shareholder Rights: When forming a C-Corp, you can choose to have several different strata of shareholders, ones whose votes count for more or less than other members. Typically, early owners or founders have a more sizable say in voting, and thus, the operation of the business. S-Corps, on the other hand, have just a single type of shareholder. It can be easier for C-Corps to expand and sell shares.
  • Taxation: For either entity, personal income tax is paid on dividend salary drawn from the company. C-Corps also pay taxes at the corporate level, while S-Corps, like LLCs, are pass-through entities. C-Corps have a possibility of double-taxation. In a C-Corp, corporate income is taxed at the corporate level, and dividends are taxed at a personal level.S-CORP V. C-CORP

In Summary,  C-Corps have more flexibility for shareholder rights and ownership but face tax implications for this privilege. In general, larger companies opt for forming as a C-Corp, where small to medium sized businesses often choose to incorporate as an S-Corp.

 

Setting up your business as either a Corporation or an LLC is worth the effort to protect your personal assets and reap other benefits.

Steven Z. Freeman, CPA and the staff at Freeman and Associates provide Business Services, Tax Planning, Entity Formation,  and Accounting and can assist you with these services. If you have any questions on this matter, or to schedule an initial consultation, Please call us at (805) 495-4211.

 

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