So you’ve decided to take the leap and start your business. You’re staring at all the options. But which business entity should you choose?
It is unquestioned that the most popular type today is the limited-liability company or “LLC”. This popularity largely comes from three (3) things: flexibility, taxation, and the reality that the majority of American businesses aren’t behemoths, but small, closely-held companies. Staying closely-held is often synonymous with single-owner or family-owned status and to a lesser extent participation in crowded industries. This means that on most occasions these companies are never going to be publicly-traded and thus aren’t affected by one (1) of the chief LLC disincentives – difficulty raising outside capital due to limited ownership structure. Instead, LLCs take advantage of generally less onerous regulations on their operation, allowing them to set up management and decision-making structures that suit them. Small business owners also like the LLC because it’s allowed to use pass-through taxation.
However, corporations can provide distinct advantages. In some states, depending on what you intend to do, you may even be required to choose this particular type of entity. First, corporations permit their owners (shareholders) to draw a salary in the conventional sense if they also work for the company as opposed to periodic profit distributions in LLCs and partnerships. While they require a specific decision-making structure at the highest levels (the board of directors) and guarantee owners certain rights (shareholder rights), many small business owners find that as long as they operate to the minimums in this area the structure provides a clear blueprint for making sure they don’t lose the protections from personal liability that a corporate structure provides should the worst happen and the company be sued. Ownership is also arguably easier to transfer later because it is made clear by allocation of specific numbers of shares to each owner.
With corporations however, there is still another choice: between the so-called “C Corp” or the Small Business Corporation or “S Corp”.
A C Corp is the classic corporate form – the original – and is the most popular corporate form for publicly-traded entities and attracting venture capital. It offers the widest variation in ownership structure, allowing for the creation of many different tiers of ownership via different classes of shares. It is also susceptible to double taxation – with the business itself paying taxes on its profits and owners paying taxes on the money they receive from the business, whether as salary and bonuses or dividends. While this is the most often-cited reason not to be a C Corp, double taxation also has advantages. If the company regularly pays out its post-tax profits to the owners as bonuses, distributions, and/or dividends, this extra tax can suppress owner income and keep them in lower personal tax brackets. It also makes it far easier to convert into any type of entity that isn’t taxed this way later on in the company’s life cycle.
An S Corp on the other hand has the corporate tax structure of an LLC or partnership, but maintains a board of directors, ownership via shares, and other classic elements of the C Corp. Perhaps most importantly to small business owners, they avoid self-employment tax being assessed on all their earnings, as shareholder distributions are exempt from self-employment taxes. These benefits do come with certain restrictions however. First, an S Corp can only have a maximum of one hundred (100) shareholders, none of whom can be partnerships or other corporations or non-resident aliens. It must be a domestic to the United States. Additionally, an S Corp does not have the same ownership flexibility as a C Corp due to the requirement that it only have one (1) class of shares. Certain types of businesses are also prohibited by law from being an S Corp.
Partnerships, sole proprietorships, and special versions of the LLC also exist as options to consider.
Because each entity carries distinct advantages and disadvantages that differ depending on the company’s plans and unique situations, you should always make your entity decision with the advice of a licensed attorney. However, there are also free resources available to give you some idea of the pros and pitfalls of each type. Still nervous about the choice? Want help understanding the next steps after filing? Follow the Garrett, Walker, Aycoth and Olson business blog or contact one of our experienced Greensboro business attorneys at (336) 379-0539.