Thinking of starting a new business? Confused about whether you should incorporate your business as an LLC (Limited Liability Company) or Inc (Incorporation)? It is a very crucial decision to make. The business entity you choose influences everything from your taxes and day-to-day operations to how much of your personal assets are at risk. So it is necessary to choose a business structure that gives you the appropriate balance of legal protections and privileges.
Should I Incorporate My Business as an LLC (Limited Liability Company) or an Inc (Incorporation)?
There are different types of business entities in the USA. The most familiar ones are LLC (Limited Liability Company) and Inc (C and S Corp). You need to understand the benefits and limitations of both to choose the business type that fits you wisely. The main difference between these two types of business entities is in the way of reporting taxes and in the paperwork required to administer these companies. Both types of companies can be owned by a foreigner. Read in detail every aspect of these entities below:
While incorporating your business, you need to know that it would be considered a legal entity that is independent of its shareholders. Being a shareholder, you will not be personally liable for the obligations, debts, or any acts of the corporation. For this business entity, you need to hold annual meetings of shareholders or directors, which makes it more complicated than LLCs in terms of administration. This type of corporation is perfect for companies who are considering getting investments. Let’s study the two types of Corp (C and S Corp).
A corporation is a legal business entity that is set up under state law to protect shareholder or owner’s assets from creditor claims. When you incorporate your business, it automatically makes you a “C” or a regular corporation. In a C Corp, the income and expenses are taxed to the corporation, not the owners. Similarly, the profits are taxed first at the corporate level and then divided at the personal level as dividends. It is not suitable for small business due to the tax feature.
If any of the below-given conditions satisfies your business needs, then a C Corporation might be the correct business type for you. If you:
- Want a flexible profit-sharing process among shareholders
- Need a venture capital for financing
- Need the flexibility to distribute your business earnings and profits between the shareholders and corporations for tax purposes.
- Want business earnings to stay in your company so that it can expand.
- Want your business to own real estate.
- Want to offer an accountable plan for entertainment and travel.
- Prefer to lower your risk of IRS audit exposure.
- Want the flexibility to set salaries for employees to minimize Medicare taxes and Social Security.
- Want to be able to easily sell your business, in case it is required.
Advantages of C Corp
- It is the most widely recognized business entity in the world, and is the premier entity for going public.
- For Wyoming and Nevada corporations, directors and officers can reside anywhere in the world. This can be a boon for foreign investors.
- With C Corp, you can have an unlimited amount of shareholders from all over the world.
- With C Corp, you have the extensive range of expenses and deductions allowed by the IRS.
Disadvantages of C Corp
- A C Corp can be expensive for its shareholders to maintain.
- C Corporations often face significant legal hurdles.
- A sheer amount of proceedings are required. Hence, making it a complicated process.
- The biggest drawback of C corporations is that they are “double taxed.” When a C corporation earns revenue, it is taxed. After that, whenever a corporation issues a dividend, the shareholders are taxed on the amount they get. As a result, the income is “double taxed.”
Once you’ve incorporated in any of the corporation’s types, you can choose an S corporation status by filing your state form with the IRS, if applicable, so that taxes, profits, and losses pass through the corporation. An S corp is a special type of corporation that is specifically designed to avoid the double taxation drawback of C corps. S corps allows that profits and losses, are passed directly through the owners’ personal income without being subject to corporate tax rates. These taxes are reported on your personal tax return as the S corporation does not pay tax.
Why Choose S Corp?
- If you fall under any of these conditions your mind your mind, you can consider choosing an S Corp:
- Want to take advantage of pass-through taxation.
- Desire flexible accounting methods. S corporations usually don’t have to use the accurate method unless they have inventory.
- Want to lower the risk of an IRS audit.
Advantages of S Corp
- An S corporation preserves the shareholder’s personal assets.
- S corporation shareholders can become the employees of their businesses and draw their salaries as employees. Additionally, they can get dividends and other tax-free distributions from the corporation, to the extent of their investment in the corporation.
- An S corporation is free from paying federal taxes at the corporate level.
- Interests in an S corporation can be freely transferred without triggering adverse tax consequences.
- S corporations need not to use the accrual method unless they have inventory.
- Operating as an S corporation may help in establishing a new business credibility with potential vendors, customers, employees, and partners.
Disadvantages of S Corp
- It has many ongoing and formation expenses.
- It may suffer from tax qualification obligations.
- It has stock ownership restriction as it can have only one type of stock.
- S corporations cannot easily allocate losses or income to specific shareholders due to one class of stock restriction.
An LLC allows you to benefit from both the partnership and corporation business structures. LLCs can be an ideal choice for medium or higher-risk businesses. LLCs protect you from personal liabilities. For instance, your house, vehicle, and savings accounts won’t be at risk in case your LLC faces lawsuit or bankruptcy. Profits and losses directly get passed through your personal income without facing corporate taxes. However, the members of an LLC are considered self-employed and are expected to pay self-employment tax contributions towards Social Security and Medicare.
LLCs have a limited life in many states. For instance, if a member joins or leaves the LLC, some states may demand to reform the new LLC with new memberships, until and unless buying, selling and transferring ownership is already mentioned in the agreement.
Advantages of LLCs
- The IRS does not recognize an LLC to be a distinctly separate entity for tax purposes. This means that, initially, the IRS will not tax the LLC immediately.
- Compared to C-Corps or S-Corps, LLCs are very manageable and flexible. With an LLC, you can create rules that govern your business. Otherwise, your company will be administered by the default rules in your state.
- Like corporations, LLCs offer their members protection from this liability.
Disadvantages of LLC
- It provides self-employment taxes.
- Corporations have specific roles like managers, directors, and employees, LLCs generally do not have such roles.
Sole proprietorship gives you complete control of your business. You’re considered a sole proprietorship if you are engaging in business activities, but have not registered yourself as any other kind of business.
Sole proprietorships do not create a separate business entity, which means your business liabilities and assets are not separate from your personal liabilities and assets. You can be personally held liable for the obligations and debts of the business. It can also be difficult to raise money because you can’t sell the stock, and banks are reluctant to lend to sole proprietorships.
Sole proprietorships can be a great choice for low-risk owners and businesses who want to examine their business ideas before forming a formal business.
Partnerships are the easiest structure for two or more people to start a business together. There are basically two kinds of partnerships:
Limited Partnerships have only one general partner with unlimited liability, and all the other partners have limited liability. The partners with limited liability have limited control over the company, which is clearly documented in the partnership agreement. Profits are passed through the personal tax returns, and the general partner who has the limited liability need to pay self-employment taxes.
Limited Liability Partnerships are equivalent to limited partnerships, but here limited liability is granted to every owner. An LLP saves each partner from claims against the partnership; they won’t be liable for the actions of other partners. Partnerships can be the ideal choice for businesses with multiple owners, professional groups, and groups who desire to test their business idea before creating a more formal business.
- As the name suggests, the non-profit organizations are set up to do education, charity, literary, religious, or scientific work to benefit the public.
- Non-profit organizations are often called 501(c)(3) corporations, which is a reference to the section of the Internal Revenue Code that is generally used to grant a tax-exempt status.
- Nonprofit organizations receive tax-exempt status, which means that they need not pay state or federal taxes, income taxes on any of the profits they make.
- Non-profit organizations need to file with the IRS to get tax exemption, which is an entirely different process from registering with their state.
- Non-profit corporations require understanding organizational rules that are very similar to a regular C Corp. Along with these rules, they need to follow other specific rules regarding what they need to do with the profits they earn. For instance, they are not allowed to distribute profits to political campaigns or their members.