The most basic element of your business outside of what colors to use in your logo can be the most critical to your tax planning strategy. Your organizations entity structure affects not only your company’s taxability, but also its benefits, and risk exposure. It’s worth the time and effort to familiarize yourself with the three most common entities. However, it’s a good idea to consult your local CPA to ensure your making the right selection for your given circumstances.
Below are the three most common entity structures:
Partnerships & LLCs
Partnerships and limited liability companies (LLC) are one of the most popular entity structures in the United States. LLCs and partnerships are taxed the same way, unless an LLC elects otherwise when it’s formed. These two entity structures receive the pass-through benefits of S corporations but provide additional flexibility.
The following are advantages of the LLC:
- More flexibility: Although a limited liability company is typically required to file articles of organization with the state, it has a more flexible management structure than a corporation. The flexibility evolves from the phrase “unless otherwise provided for in the operating agreement.” This allows business owners to create a structure tailored to the business owner’s requirements.
- Limited liability: As its title suggests, the LLC protects owners and shareholders from personal liability in case of judgments or debts against the business.
- Tax options: An LLC can choose whether it wants to be taxed as a sole proprietorship, partnership, S corporation, or corporation.
- Perpetual existence: Like a corporation, an LLC has a life of its own and can continue to exist after the owners sell their shares or die.
There are also some disadvantages to an LLC:
- Raising money: Because of the lack of a strict corporate structure and the pass-through taxation, investors may be hesitant about putting their money into an LLC.
- Additional taxes: Many states, such as California, New York, and Texas, to name a few, require LLCs to pay a franchise tax or “capital values tax.”
- Less structure: The lack of strict requirements for governing the business could mean problems down the road unless a detailed operating agreement is in place, which requires additional upfront costs such as attorney fees.
Continue to read about the LLC – http://bit.ly/23XJlv6.
S corporations benefit from pass-through taxation. They also use stock as a form of ownership interest. An S corporation requires careful planning and ongoing monitoring in order to deal with the many concerns surrounding shareholder basis and distributions.
The following are advantages of the S Corp:
- Eliminating double taxation: In an S Corporation, profits and losses are passed through to shareholders, and taxes are only paid once. Check with your state to see how it handles S Corporations. A few states do not recognize S Corporations and will tax such businesses as a regular C Corporation. Some states charge S Corporations a state tax, although, absent unsual circumstances, the corporation will not have to pay federal tax.
- Protection from liability: As the owner of an S Corporation, your personal assets are separate from the business’s assets and are therefore protected in case any judgments occur against the business.
There are also some disadvantages to an S Corp:
- Rules and fees: Like a C Corporation, S Corporations are required to file a number of official state and federal documents, including Articles of Incorporation and corporate minutes. They must also hold regular shareholder meetings and pay the required government fees.
- Shareholder restrictions: Realize that if an S Corporation has shareholders, the shareholders will be taxed for any income the company has, even if they did not receive any portion of that income. (In a C Corporation, shareholders are taxed only if they receive dividends.) In addition, S Corporations are only allowed to issue one class of stock, which may discourage some investors.
- Salary requirements: The Internal Revenue Service requires all active officers and owners of an S Corporation to make a salary, even if the company is not yet making a profit. This could be problematic for new businesses struggling to make payroll. A “reasonable salary” is what a person with the appropriate skills needed for the position would be paid on the free market.
- Room for investors? S Corporations are limited to having 100 shareholders. While this number is higher than it used to be, it may still limit the ability to expand your business through capital infusions from new investors.
Continue to read about the S Corp – http://bit.ly/2aX6Q3C
Owners of C corporations are subject to double taxation. Though there are ways to mitigate the adverse effects of the corporate level tax during a normal business year, the double taxation makes certain elements of business more costly. Selling a C corporation triggers double taxation. Holding real estate inside a C corporation can also magnify the double taxation issue.
The following are advantages of the C Corp:
- Liability protection: Because the C Corp is legally an entirely separate entity from the owners and shareholders, owners and shareholders cannot be held responsible for any debts of the C Corporation or any lawsuits brought against it. In other words, your personal assets will not be affected by the actions of the corporation.
- Attracting investors: A C corporation can sell stock or shares, either common or preferred — and there’s no limit to the number of shareholders. If you ever plan to go public, you’ll also need to be structured as a C corporation. In addition, the C corporation form allows you to offer employees a stock option plan.
- Taxes: Because the corporation is a separate entity, the profits and losses of the C Corporation are retained for the corporation. Unless you or your shareholders receive dividends, you will not be taxed on the company’s income. Also in your favor, you can deduct business expenses and employee benefits in your tax filings.
- Lower tax rate: You also have the option of splitting profits and losses between the business and the owners to create an overall lower tax rate. Check with your accountant on the best way to do this for your situation.
- Perpetual existence: A C corporation will exist indefinitely, even if a shareholder or owner leaves, becomes disabled, dies, or sells off their shares.
There are also some disadvantages to a C Corp:
- Higher costs: Corporations pay a number of state and federal filing fees, and each state also has its own set of regulations. Dealing with these regulations may require the professional expense of an attorney or accountant.
- Increased paperwork: Increased regulations and complex rules require a corporation to file a number of documents, including Articles of Incorporation, corporate bylaws, corporate minutes, certificates of good standing, and more.
- Double taxation: Owners of the corporation pay a double tax on the earnings of the company, and shareholders must pay taxes on the dividends received. However, if the owners take a salary, the corporation is not required to pay tax on the earnings, since the offsetting salary payments are considered a business expense.
Continue to read about the C Corp – http://bit.ly/1such23