Breaking Down Your Business to Its Entity
Posted by Erica Bell on July 24, 2013 in Business Financing, Business Management, Incorporation [ 0 Comments ]
Starting a business isn’t easy. It takes a strong product, great customer service and marketing, and perseverance. Part of starting a business is paying close attention the financial side of things. Choosing the right type of business entity is a crucial initial step for new business owners and startup founders. Selecting the right legal entity can make all the difference in liabilities, risks and profit potential. Here’s a quick breakdown of the three primary types of business entities and tips to help you determine which is the best for your business.
C-Corp (C Corporation)
Small and medium-sized enterprise owners may find that a C-Corp company isn’t in their best interest, but that there are some advantages should they choose to go this route. If your business has some serious backing to start with, and you’re looking to raise more capital through the sale of stocks to investors, a C-Corp may be for you. Some of the advantages of listing your business as a C-Corp include:
- Limited liability protection, meaning you won’t be hold personally responsible for business debts.
- Lower audit risk. Typically, C-Corps are less likely to be audited than sole proprietorships (SanDiegoBizLaw).
- Self-employment tax savings. C-Corps minimize the self-employment tax since owners who work for the business are considered employees.
Be wary before you jump right in to a C-Corp listing, though, as this type of entity isn’t for everyone. Tax deductions based on business expenses will be less feasible and profits will be “double taxed,” meaning your profits would be taxed when earned and again when distributed as dividends to shareholders.
S-Corp (S Corporation)
S-Corporations are taxed as a pass-through entity and don’t pay taxes at the corporate tax rates. S-Corps are required to file an informational tax return while any profit or loss is reported on the shareholder’s personal tax return. For those considering listing themselves as an S-Corp, consider the following benefits:
- Pass-through taxation. Usually S-Corps will not have to pay taxes at the business level and the profit or loss is reported on the owners’ personal tax returns and any taxes that are due are paid at the individual level.
- Elimination of double taxation. Your income will only be taxed once.
- Credibility. Your business may be perceived as more professional by forming an S-Corp than it would be if it was a sole proprietorship or partnership.
Become an S-Corp isn’t easy though. You’ll need to be a domestic corporation that has no more than 100 shareholders and you’re allowable shareholders only include individuals, certain trusts, and estates. For example, partnerships are prohibited and you can’t raise capital from a VC firm.
Related: Startup Tuesday: Securing Funding
LLC (Limited Liability Company)
Similar to C-Corps, LLC owners have limited liability protection. In most cases, owners aren’t held responsible for business debts. Therefore the ability of a creditor is limited in pursuing unpaid business debts. This isn’t the only benefit afforded to LLC owners. Other advantages include:
- There’s no residency requirement. Owners are not requires to be U.S. citizens or even permanent residents.
- Flexible management. Less annual paperwork and the lesser chance of being audited allow LLC owners greater flexibility in management of their business.
- New owner consent. LLC members must consent to new ownership before it can take effect.
LLCs are limited, however, in what they can do in regards to taxation and stock issuing. LLCs can’t issue stock as this could attract investors, which is a no-no for LLCs. They also cannot engage in income splitting to lower tax liability.
Ultimately, the best business entity for your business will be dependent on what is you hope to achieve in the long run for your business. While you can shift your business from one to another, a new license is required and a change could impact your business in unexpected ways, so it’s best to choose the best route right from the beginning. The above advantages and disadvantages of these major types of entities should help aid you in your decision.
(Image: naypong via freedigitalphotos.net)