Which type of corporation is best: LLC, S corp, C corp, etc.
First, an important disclaimer: I am not an accountant. I am not a lawyer.
This is a topic that affects your tax liabilities and your legal status so you need to educate yourself on the basics of this topic as well as discuss this in detail with an accountant regarding the tax implications and an attorney regarding the legal ramifications.
* * * * *
There are three main types of corporate entities that you will consider as an entrepreneur, all of which provide liability isolation but each with different tax consequences:
- C corporation
- S corporation
- LLC and its variants
The best type of corporation for your business depends on many factors. In a very broad sense, if you are planning to seek outside equity (stockholder) investors to fund your business, then a C corporation will probably be best. A C corporation will be a requirement for any institutional investor and most angel investors. If you are planning a small-scale, lifestyle business and just need some liability protection, an LLC can be very inexpensive to create and maintain, while retaining simple, low-cost tax preparation and accounting costs.
If you are operating your business as a sole proprietor or as a partnership, you are directly legally and financially responsible for everything that happens with your business. If someone spills hot coffee on themselves and sues the business, you are personally responsible.
If you operate your business as a properly formed and maintained corporation, then the corporation and its assets are responsible for any liability of the business, not you personally.
Consequently, most entrepreneurs form a corporation for their business due to liability concerns. The corporation can form a shield between you and the litigious nature of U.S. society. The corporation, as a legal entity, can provide a layer of liability isolation between you—as an individual, and your financial assets—and the activities and legal liabilities of the business.
In a practical sense, there are limits to this “corporate veil” and the veil can be “pierced” by a lawsuit in some situations, so don’t consider yourself forever personally protected from legal liability just because your company is a corporation. In particular, it is important to maintain your corporate minutes, hold regular board meetings and follow both the spirit and letter of the law regarding your corporation.
However, in general, if you are operating your business as a properly formed, registered and maintained corporation, you will enjoy some measure of personal liability isolation from the lawful actions of the corporation in its day-to-day activities in business.
All three types of corporation, C, S and LLC, provide liability isolation for the shareholders.
A C corporation is regarded as a separate entity or individual for tax purposes by the federal and state governments. A C corporation files its own tax returns and makes its own tax payments. The income of a C corporation is taxed separately from the personal income of its shareholders. This can lead to “double taxation” for any salary paid to you as a shareholder.
An S corporation is taxed as a partnership, with all profits and losses flowing directly down to the individual shareholders’ personal tax returns. This avoids double taxation, but the S corporation can have different rules regarding deductible expenses and other factors that can affect taxable income (profits).
An LLC is a type of corporate entity that is essentially ignored by the federal government for tax purposes but recognized at the state level. From the federal tax perspective, an LLC is a partnership, and you will owe federal taxes as if you were operating a partnership. At the state level, the LLC is recognized and is taxed differently than a C or an S corporation.
Tax rates for C and S corporations and LLCs can and will vary on a state-by-state basis. Some states have stepped tax rates for LLCs that can lead to increased or decreased tax liability relative to other forms of corporations depending on the amount of taxable income the company generates. This means that as your LLC company creates more taxable net income (profits), your tax rate can vary depending on which “step” of the scale you occupy.
To make things even more complicated, an LLC can elect to be taxed as an S corporation in order to alter its federal tax liability related to certain taxes. This is just one of the many reasons why it is very important to discuss this issue with a qualified attorney and accountant.
Each type of corporation has its own unique upsides and downsides for an entrepreneur. There is no magic bullet, one-size-fits-all answer to which type of corporation is best for you. Determining which type of corporation is best for your unique needs and situation requires careful consideration of the factors involved and that is best done by working with trained professionals.
* * * * *
To learn more about the types of corporations and other legal aspects of business, I recommend this excellent book by startup attorney Coco Soodek, Birth to Buyout. The book is available in paper and electronic editions at all major outlets, including Amazon: http://www.amazon.com/Birth-Buyout-Life-Cycle-Business/dp/0983425809
* * * * *