When considering the type of company you want to establish, various options could work for your business. For example, an LLC or S corporation can help determine what taxes will be filed and how much liability protection each has from lawsuits.
Choosing which type is best for your needs requires careful consideration because it’s essential in terms of potential tax benefits and protecting yourself financially if something goes wrong with the company, like being sued by another party.
Moreover, suppose high net worth investors fund your business. In this case, incorporating as an S Corporation may not offer them enough protection against personal liabilities incurred in their capacity as shareholders.
Limited Liability Companies have some exciting features which make them attractive. Yet, many restrictions can limit their attractiveness in certain situations, and this article will outline those cases when LLCs may not work well as business entities.
It is always crucial for entrepreneurs to determine whether their start should be a limited liability company or an S corporation.
Overall, this piece outlines the factors you need to consider before deciding what type of entity your new business needs to take on; it’ll help guide you through choosing between forming either an LLC or S-corp so that nothing goes wrong along the way.
What is an LLC?
Limited Liability Companies (LLCs) is a business structure that protects the personal assets of its members. Therefore, if your company gets tangled in legal troubles or issued by a debt collector, they can only go after your company’s assets, not those of the LLC member(s).
This protection comes in handy if your business gets tangled up with legal troubles. Then, no one can go after you but only at the expense of whatever asset they are going after from within your organization.
Since an LLC is taxable as a take entity, its profit margin streams to the partners provide a significant advantage.
The only downside is that owners will have to pay self-employment tax on their income instead of filing one corporate tax return.
A sole proprietorship can save quite a bit in taxes by organizing themselves as an LLC because they’ll be considered a partnership or corporation depending upon the number of partners.
Members then pay taxes on these earnings at their rate. This is done with only one layer between your company and you (as opposed to corporations with many layers).
The upside for this structure can be that it’s more accessible from an operational perspective because all of your transactions are handled internally rather than having complicated accounting relationships with other companies like suppliers or customers outside the group.
An alternative option is that rather than being taxed traditionally with income tax rates applying based on how much you make in wages, your limited liability company may also file its taxes through what’s called pass-through taxation where instead, the entity itself doesn’t owe tax unless there was some capital gains activity going on which means when companies make money then, default owners will receive dividends if enough profit remains after necessary reinvestment.
What is an S-corp?
The S corporation(S-corp) is a tax-election entity that prevents double taxation. The S-corp has become a favorite for many small business owners looking to run their companies as pass-through entities.
The reason being that it prevents the company from incurring corporate-level double taxation and is easy enough for any new or existing C Corp, LLC, general partnership, trust with an elected beneficiary (grantor), or sole proprietorship to register in state government affairs offices.
All you need are primary documents like articles of incorporation and operating agreement plus filing fees, which can be paid online by credit card.
S-corp allows business owners to be employees and shareholders simultaneously. Here, the profits are taxed at the shareholder level, while losses or deductions may also apply depending on how they were allocated in your tax return for that year.
This corporation should contain 100 shareholders who are business owners and can be located anywhere in the US as long as they file an IRS form for American corporations.
What Is The Difference Between An LLC or S-corporation?
The decision to structure a business as an LLC or S-Corp should not be taken lightly. The two structures have different tax implications, but they also differ in how various aspects of ownership are structured.
One factor that can help you choose is whether taxes will play a significant part in your company’s success; if so, consider going with an LLC because it allows for more potential deductions than the traditional corporation.
If choosing this option risks exposing too much personal information about yourself to other people (such as investors), there may be no need for any taxation at all.
Generally, the path you choose will depend on what type of company and owner you want your small business to be – whether it’s someone who wants more control over their finances, those looking for less paperwork with fewer expenses such as taxes which come at time cost associated with running the day-to-day operations; or owners seeking specific types of protection under the law from creditors (i.e., personal liability protection).
An S-corp is an excellent way for businesses to avoid double taxation. This type of entity does not have the same tax obligations as other business models, and it can save you money in taxes with its exempt status.
An LLC allows members (owners) flexibility in determining what entity type best suits their tax requirements, depending on ownership preferences, like whether one prefers at least two levels of protection against liability claims over immediate personal control afforded by smaller companies.
Some may think this leaves them open to double taxation. Still, in reality, it’s an easy way for business owners who have different needs and wants from their company structure, such as paying employees or being non-disabled investors – by turning into either an S corp when dealing with federal taxes only, or C Corp if they want their statuses on both state and federally recognized entities.
The S-corp includes as part-owners any person who invests in the company. This means shareholders are paid a salary and their payroll taxes by the corporation, making them eligible to deduct these expenses when filing with the IRS.
After spending all bills (including shareholder’s salaries), they will distribute dividends whenever there are excess profits, making this rate lower than regular income tax rates.
LLCs’ tax implications and management styles can be similar to S-corps’, but some key differences are.
LLCs differ from corporations because they do not separate ownership and control or daily company decisions. However, one significant distinction is how taxes apply because, unlike an LLP, if managers rather than members manage it, it mimics a corporation when it comes down to taxation levels.
In S-corporations, a board of directors supervises organizational protocols and meaningful choices, whereas elected executives manage day-to-day operations.
Lastly, LLCs and S-corps differ when it comes to assets, subsidiary rules, and ownership systems. For example, an LLC can set up subsidiaries without restriction, while a corporation cannot issue stock of any kind whatsoever.
Furthermore, S-corps are limited to 100 shareholders, while LLCs can have many members. Additionally, non-U.S citizens aren’t allowed in S corps, but they’re permitted for an LLC membership.
Is an LLC or S-corp Better For Entrepreneurs?
Some entrepreneurs struggle with this critical question. Nevertheless, the answer to this is not clear, and there may never be a straightforward answer that will work for everyone.
There’s no single right way of doing things in the world, so it boils down to what works best for you.
For example, some people might think LLCs have more tax benefits, while others believe they would rather pay taxes on their income than worry about other issues like personal guarantees. It all depends on your specific needs.
However, some factors and facts may help in wise decision-making. For example, both offer benefits such as liability protection and tax write-offs, but what’s better for an individual depends on how far the company is.
If it’s a startup stage, then starting by filing to become an LLC makes sense because this structure offers those particular advantages among others at that point of growth.
If your business has grown past its initial stages and you’re looking into making more money than what you could get from just being taxed like regular income (which many people try), switching over to becoming an S-Corp may be best since there isn’t any other option outside of taxes beyond.
The owner’s income can be minimized with self-employment taxes and a Foreign Earned Income Exclusion with an LLC. If you live abroad, S corporation is your best option for reducing tax rates on both types of taxation.
“Many people choose to start their business as a single-member LLC, such as myself. But despite the popular belief that S-corps are more financially advantageous for many businesses if you’re already in an LLC and it doesn’t make sense to switch over, then don’t.”These were the words of Anthony Viola, who is currently running his CPA firm located in Queens, New York.
Anthony Viola advises small businesses on how best to manage finances throughout various stages of growth while providing accurate accounting services where needed.
Other Types Of Formation:
In a sole proprietorship, the owner and all of their assets are the same. If you have personal debt, your company will take on that responsibility as well.
This type of operation can be suitable for low-risk businesses or individuals who don’t want to spend money starting up another legal entity such as an LLC or corporation.
However, it’s not always easy to dissolve these types of companies. People could end up with big tax bills when they close out this form of ownership if there isn’t much income generated by the business operating under this structure.
In today’s competitive market where many new companies pop up each day, starting one on your own might sound appealing due to its simplicity: You need an idea and begin operating under this type of business model in which there isn’t any separation between the person or company from their wealth.
Partnerships may be the most straightforward way to enter business with other people. Limited partnerships are a variation of this where one or more partners will have limited liability for any debts incurred by the company, while others would not (LLP vs. LLP).
When deciding on which type of partnership you want, all parties must understand their level of involvement in management and risk-taking before entering into anything binding.
A corporation is a legal entity separate from the people responsible for running it. A benefit of this separation is that corporate life and its shareholders are not entangled with each other, which means there won’t be any disagreements between them over company decisions or profits in general.
It also allows corporations to pursue ventures without risking shareholder money; they can invest more heavily into something. However, if anything goes wrong, shareholders will lose their investment while those involved only risk time spent rather than the capital invested (in worst-case scenarios).
B Corps are for-profit companies that also take into account the company’s social and environmental performance.
Third-party certification services verify your business as one of these socially responsible entities, which can be beneficial to give you access to markets with buyers who value those attributes in their products or partners.
How does it work? A third party certifies your organization after assessing its practices against rigorous standards developed around issues like transparency, accountability, and sustainability. They then provide this verification seal on all communications materials so customers know they’re buying from an ethical producer.
Should you form an entity at all?
If you’re the sole owner of your company, it might seem like there’s no need to form an entity. But while some benefits come with establishing a formal LLC or S-Corp (if state law requires), making sure they fit what type of business you want to be in is necessary too.
The right decision from a government perspective would depend on individual circumstances, like how big a company will grow over time and can’t always be made based on doing research online alone.
First, ask yourself, does your business have potential liability issues?
Single-owned businesses should form an LLC to protect themselves from liability issues.
The benefits of forming a limited liability company include protection for the business and its owners or employees and better tax breaks than those afforded by sole proprietorships.
The size of your business will help you determine if this type of entity would be beneficial – take into consideration how many other people are involved in your operation before making any decisions about what kind of legal structure to take on board within your organization’s scope.
This structure includes asset shielding, which protects personal assets from claims against the company that could occur due to its ongoing activities. This shield operates as long as individual members have substantial control over their respective shares per applicable provisions.
How much does your state charge for forming/running an LLC or corporation?
Your state law entity can be a powerful decision for your business. If you want to form an LLC, the process is relatively straightforward and takes just one filing with the Secretary of State in whichever jurisdiction you choose.
There are more steps involved for corporations, including bylaws and filings with federal and (in some cases) local governments.
To establish which type of “state law” entity works best for your startup company, it’s essential to consider factors such as how much capital has been raised or if any investors were given voting shares despite what many people believe about these types being exempt from security regulations since they’re not publicly traded companies.
There are many new questions to consider before deciding whether a sole proprietorship, partnership, or limited liability company (LLC) is best for your needs.
A corporation offers the most protection in terms of avoiding personal responsibility and limiting exposure on assets from lawsuits but also requires more time invested upfront.
Sole Proprietorships offer fewer formalities with no requirement that the state law registers them, unlike LLCs, which have this requirement unless they choose S-Corp status, making them even more complicated than corporations with double taxation ramifications if not set up correctly.
Understanding all aspects of these structures will help filter through what might work best for you under different circumstances.
Determine if Your Company is More Like a “Business” or a “Scalable Startup.”?
Businesses and startups are two completely different entities. Business owners tend to be more insular, often relying on their knowledge of a product or service for them to maintain enough money flow.
Meanwhile, startup entrepreneurs rely on innovative ideas, which can create an entirely new market with little risk involved because it’s not competing against established businesses that already dominate those markets.
The following two questions will help you identify whether your company is a Business or scalable startup:
- Is my product/service B2C (business to consumer)? If yes, then it’s most likely a Business; if no, what is the nature of your target market?
- Do I have long-term goals like ten years from now? We classify companies as “scalable startups” when they are in an industry with growth potential and would expand with more resources over time.
An excellent example of this type of company might work in tech, such as UberEats which provides food delivery services for restaurants in almost every city.
Determine whether your company fits better under the business or the scalable startup or bypass the formation process and discover how to develop a startup correctly at The Vertical Method if you’re still undecided.
The real talk from Robin Copernicus (what you won’t learn on Quora):
Whether to do an LLC or an S Corp is a question that many entrepreneurs let slow down.
There are only two reasons you should be considering whether you should start an LLC or an S corporation.
The first reason is that you want to limit your liability. The second reason is that you want to structure your taxes beneficially.
Emerging founders likely don’t have an asset base to protect anyway. So they are trying to limit their liability before they even have customers to solve a problem they don’t have yet.
In terms of structuring your taxes, this is best left to a tax professional.
You will need to get the advice of not only your accountant but also a qualified tax lawyer. Whether you get an LLC or an S corporation or a combination of the two depends on your situation.
For me, I’m a digital nomad. One benefit of being a digital nomad is that I don’t get tax on the first $100,000 of my income. This means I am better off setting up a corporation that pays me a salary of up to $105,000 instead of getting an LLC. Anything after that, $105,000, however, would be taken as a distribution from an LLC. There are so many other nuances to make this decision; getting proper personalized insight for your specific situation will be difficult from a blog article.
If you want some leads on some accountants that you can speak to, feel free to reach out.
However, before you even think of going down this route, do you even have a viable business yet? Are people trying to hand you money?
If not, work on growing your customer list before you consider spending money on LLCs and S-Corps.