Once you’ve outgrown a sole proprietorship, or when you realize you need the legal protection that a formal business entity provides, you may be wondering how to choose between an LLC and a Corporation, and what the advantages are of an S election. Forbes recently ran an insightful article that discusses the differences, and an article in Mashable gives some good advice as well, particularly for startups. Here’s what you need to know.
Any of the three structures will give you personal legal protection against litigation. If someone sues you, claiming you cost them a million dollars of potential revenue, for example, you won’t lose your home.
C corporations are double taxed.The corporation pays tax on its net income, and then shareholders pay tax on distributions to them. The advantage of the S election is that income from an S corporation is taxed only once at the shareholder level, so you’ll pay taxes like an LLC.
Corporations are independent legal entities that are owned by shareholders. They offer the ability for the founder(s) to “go public” and sell ownership shares through a stock offering. S corporations are limited to 100 shareholders, so if you want to go public you’ll need a C corporation.
More Than One Owner But Unequal Work
If your business has multiple owners who put in unequal amounts of work, you may want to go with an LLC since an S Corporation requires that profits be divided equally among the owners.
Both LLCs and S Corporations allow you to pass business losses along to your personal income reporting, but in many cases (notably real estate) the LLC allows you to pass along more.
With S Corporations and LLCs, owners are liable for any taxes owed on profits — whether that money is retained in the company or put in their personal bank accounts. So if you want to reinvest a lot of profits back into the company, you may want to go with the C corporation to avoid taxation of “phantom income.”
Raising Venture Capital
VC companies want to invest in C corporations. Although you don’t have to start out as a C corporation, know that before you get to the stage where you’re approaching VCs, you’ll need to convert to one. It’s easiest to convert an S corporation to a C corporation, so you may want to consider starting with that.
Each business has its own needs and plans for growth, so there’s no one “right” answer for which is the best entity to choose. If you have questions, or if you need help thinking through the business entity that’s the best for you, give me a call at (864) 836-3136 and we’ll schedule an appointment.