Incorporation Soup: Deciding on a Corporate Form

 

Congratulations Entrepreneur. You made it through the hard part. You thought long and hard, carefully crafting your vision, honing your dreams, and creating a plan to put it into action. Now all you have to do is fill out some paperwork and dive head first into your new endeavor. So, armed with anticipation, you google ways to incorporate and are confronted with an alphabet soup of options: PC, PLLC, LLCs, S-Corps, C-Corps. Or maybe you heard of an LLC, know some of its benefits, and think that’s the way to go. Either way, take a few minutes so we can debunk some of the myths and misinformation and address the strengths and weaknesses of the three ways to incorporate.

Generally speaking, there are two organizational options for your business: a partnership or incorporation. A partnership allows profits from your company to flow directly through to you, the owner(s)—meaning you are only taxed once, at the individual level, for your organization’s revenue. Money Alert. However, with a partnership the owner(s) are personally liable for the company’s debts. Money Alert. So if the business fails and dissolves through bankruptcy, you, Ms. or Mr. Owner would still be liable to the business’ creditors. Money Alert. Incorporating as an S or C Corporation or a LLC allows an owner to avoid the personal liability. This happens because unlike a partnership, which is tied to the owner, a corporation is a separate entity. Small Business Info. Regardless of your role, be it president or sole shareholder, you (owner) are independent of the corporate entity. Investor Guide. The privilege of limited liability, however, comes at a cost and knowing the costs and benefits of each of the three types of incorporation is critical in maximizing not only your businesses profit, but its potential.

C-Corporations are the Big Daddy’s in the corporate family; examples include Nike, ExxonMobil, and McDonalds. There isn’t much you can’t do with a C-Corporation, but Big Daddy demands a lot in exchange for that freedom. Helium, Nelson. As a C-Corporation revenue is subject to double taxation because all the profits the company makes are subject to the corporate tax rate plus the dividends and salaries paid to the members (shareholders) are also taxed at a personal level. Money Alert. C-Corporations also have a lot of corporate formalities including a formal issue of stock to shareholders, regular meetings of directors and shareholders where minutes are taken, and adequate capitalization to name a few. Investor Guide. In exchange for all of that, you as a shareholder in a C-Corporation can sell and create different classes of shares, sell them to an unlimited amount of shareholders (including corporations), and in certain instances, like mergers, a C-Corporation can even save money on taxes. Biz Filings.  So if you have big dreams for your corporation, foresee the need to raise a lot of capital through the issue of stocks, or hope to one day merge with another organization, a C-Corporation is the way to go.

If C-Corporations are the Fathers of the corporate family, then S-Corporations would be the little brother. The biggest difference between S-Corps and C-Corps lies in taxation. For starters, S-Corporations are “pass-through” entities, meaning taxes pass through the corporate level straight to the individual. This allows you to avoid the double-taxation that C-Corporations shareholders are subject to. Biz Filings. S-Corps also have a tax advantage over the LLCs. With an S-Corporation, only wages (i.e. your salary as president) are subject to a “self-employment tax,” not all of your profits. LLC Center. So if your LLC made $80,000 profit, but you only made $40,000 serving as CEO, you would pay self-employment tax on the entire $80,000 whereas with an S-Corp the tax would only apply to the $40,000. Like their big brother, S-Corporations are subject to all the same corporate formalities.  LLC Center. S-Corporations can still issue stocks, but the number of shareholders cannot exceed 100 and must be US citizens or residents (this also means other corporations cannot be shareholders). Biz Filings S-Corp.

LLCs, or limited liability companies, are the lovechild of the corporate form—being that they are a hybrid of corporations and partnerships. True to their name, LLCs create a separate entity, therefore limiting the liability of its owner(s). Residual Rewards. Like an S-Corporation, LLCs are pass-through entities, so taxes are only deducted once at the individual level. LLC Center. Limited liability aside, LLC’s begin to resemble more of a partnership. Gone are the strict corporate formalities that make S and C-Corporations such a high-maintenance venture. Biz Filings LLC. The freedom from procedure means more than just less work; profits don’t have to be split up according to ownership. LLC Center. For example, if A put in $90,000 and B put in $10,000 to form an S or C-Corporation, B would only be entitled to 10% of the profits as a 10% shareholder (salaries notwithstanding). With LLCs however, owners have liberty when it comes to arranging profit distribution. The liberty with share distribution makes sense given that owners of an LLC cannot sell stock (shares) in the company, which is its biggest drawback. Money Alert.

Knowledge of corporate forms is the fuel necessary to ensure your spark can grow according to your vision. Yet, even this lengthy description is but an introduction to the intricacies of the corporate form. Give your idea what it needs to succeed. Before you incorporate, talk with a lawyer or experienced entrepreneur about the intricacies of each structure to determine which can most adequately meet your individual needs.

by Nick Allen, summer intern

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