How to Incorporate Your Business and Why…
Today’s pathway to business success includes incorporation. Incorporation gives you pride and credibility and helps you organize your business. As an incorporated entity, you signal the world you’re serious about your business and you’re committed to making serving your target market and customers. A corporate entity can help you build your brand and position your company for growth. Investors and lenders typically want to invest/lend money to incorporated businesses rather than individuals.
Equally and often more important, a corporate entity can help protect yourself and your assets from liability—that’s crucial in today’s litigious society. In addition, businesses are entitled to take advantage of certain tax benefits and conducting your business through a corporation has been shown to reduce the risk of IRS audit.
Three Forms of Corporate Entities to consider
Today there are three primary forms of corporate entities: the C-Corporation (also called C-Corp.), the S-Corporation (S-Corp.) and the relatively new Limited Liability Company (LLC).
While choosing the best entity for you can seem confusing, The Small Business Advisors will handle the entire process for you.
There are three main types of entities:
- S-Corporation or “S-Corp.”
- C-Corporation or “C-Corp.,” and
- Limited Liability Company or “LLC.”
The ‘S’ and ‘C’ in S-Corp. and C-Corp., respectively, refer to chapters in the Internal Revenue Code or “IRC.” Now that you have the lingo, let’s explore each type of entity.
C-Corporation or C-Corp.
Typically, companies that trade on an organized stock exchange are C-Corporations. Stockholders own a C-Corporation and there are no limits on the number of shareholders. For example, Microsoft has millions of shareholders and for a company like this, shareholders have a high level of liquidity, for example they can buy and sell shares of stock easily. The corporation can also borrow money without the loan itself impacting the shareholders. Of course, if the company loses money the shareholders can lose the value of their investment. A C-Corp. is considered to be a “separate person” legally and for income tax purposes. This means that in almost all cases the individual owners cannot be held liable for the actions of the corporation or its management.
Advantages of C-Corp.: The C-Corporation has an unlimited life, separate from the illness or death of any owners. In other words, when the founders or even a major or controlling shareholder dies, the Corporation’s existence continues.
Disadvantages of C-Corp.: Like most things, there are several disadvantages to C-Corporations. The main one is “Double Taxation.” This means that the corporation is taxed on its profits (sales revenue minus expenses) and then when it pays dividends (distributions to its owners) the dividends are considered to be a distribution of after-tax profits; the corporation does not receive a tax deduction for dividends it declares while the recipients typically are liable for income taxes on dividends received. In other words both the corporation pays tax on its earnings and the shareholders pay income on dividends they receive, hence double taxation. Another consideration is that recordkeeping can be more involved for a C-Corp. than other forms of entities.
S-Corporation or S-Corp.
An S-Corporation is a corporation that stands alone from its owners for liability purposes but is also known as a “pass through entity” for income taxes. Unlike the C-Corp., the S-Corp. does not pay income taxes on its profits but rather passes through those profits to its shareholders. Each shareholder reports his or her share of the S-Corp.’s income and losses on his/her individual income tax return.
The S-Corporation is owned by a limited number of stockholders (typically a maximum 75 but this can vary by State). S-Corp. stock is easily transferable and can be sold to raise capital but must be within IRS guidelines. Like the C-Corp., the S-Corporation has an unlimited life, separate from the illness or death of any owners.
Advantages of S-Corp.: The main advantages to S-Corporations include limited personal liability for the S-Corp.’s debts and no taxation of profits to the corporation since the profits are taxed at the individual taxpayer level. S-Corporations prepare an information tax return known as a Form 1120S and a Form K-1 for each shareholder. For example, if there are 10 individuals who own equal stakes in the XYZ S-Corp., and the S-Corp. earns a profit of $1,000,000 this year, each shareholder would receive a K-1 that allocates 10% of the S-Corporation’s income (profit) to him/her, or $100,000 (10% of $1,000,000). The S-Corp. owners may receive some income tax deductions for certain business expenses.
Disadvantages of S-Corp.: The main disadvantages to S-Corps. include the fact that it an S-Corp. must distribute its income to the shareholders in accordance with the owners’ ownership interests. While an S-Corp. is typically less complicated to run than a C-Corp., an S-Corp. is typically more complicated to run and manage than an LLC.
Limited Liability Company or LLC
A Limited Liability Company or LLC is similar in many ways to an S-Corp., but the LLC is more flexible and faces fewer rules and regulations. Each LLC member (owner) pays income taxes on his/her share of the LLC’s profits at his/her own individual tax rate. For this reason, the LLC is also a “pass through entity” similar to an S-Corp.
LLCs must file an operating agreement with the Secretary of State in the State in which they establish their LLC. The operating agreement explains the management and guidelines of the corporation. The operating agreement governs raising capital, transfer and selling of shares. Each State sets different requirements so be sure to engage professional advisers.
LLCs do not issue shares of stock; instead the LLC issues member units or interests that represent ownership. However, LLC owners benefit from limited personal liability for company debts as with the C-Corp. and the S-Corp. If the company is sued, only business assets, not members’ personal assets, are at risk. Members can sell or transfer their interest(s); however, any sale or transfer is subject to any restrictions that may be in the operating agreement.
Advantages of LLC: First, LLCs offer limited personal liability for the LLC’s debts. There is no taxation at the corporate level, no double taxation. LLCs are not typically limited in the number of members the entity can have. LLCs are easier to manage and require less paperwork than the S-Corp. and C-Corp. LLCs offer a relatively high level of flexibility in company structure and management.
Disadvantages of LLC: It is typically more difficult to transfer ownership of an LLC than with an S-Corporation or C-Corporation. And, as the newest business structure, there are fewer laws governing the LLC’s management, operation and maintenance; and fewer established precedents exist.
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There are numerous sound reasons to select a particular form of corporate entity, but once you decide to launch your business, it’s often prudent to incorporate your business. Incorporating offers many benefits and opportunities, including branding and capital raising And of course, protecting yourself and your family from liability: limited liability.
At The Small Business Advisors, our Team of Incorporation Specialists is waiting for your call. We have over 35 years of business and corporate experience and look forward to helping you launch your business and achieve the success you desire.