By: Allen T. May, C.E.O. of Westwood Associates, LLC
Greetings and salutations fellow entrepreneurs. I get a lot of emails regarding an LLC in contrast to the C-Corp and S-Corp so I decided to address it in this week's blog posting. Choosing your legal entity is a crucial choice when starting your new business and you should give it the consideration it well deserves. There is no one answer fits all with this decision. The "right" choice varies from business to business. This is an important matter that you will need to discuss with your partners, if any exist as well as with your CPA. If you don't have a CPA.....GET ONE! Yes, they charge by the hour and yes they can be expensive. However, its money well spent and in the absent of a CPA on your "team" can quickly translate into significant tax liability. I cannot articulate enough the value of hiring a CPA. You don't need to pay the fees commanded by such accounting firms as PriceWaterhouseCoopers, but you do need pay someone who has current business and tax law knowledge and experience. Shoot me an email and I'll gladly recommend a few for you to contact. Okay, enough of my soapbox on hiring skilled accountants. Lets move on.
Which entity you the entrepreneur choose will have a huge impact on your exposure to legal liability as the owner of the company, and will also help determine how much you and your company will pay in federal income taxes. Another aspect your liability can affect? How much your business grows, and how much money you can raise. Here are some considerations to ponder when making a decision for you and your growing business venture, plus some other legal aspects to consider.
There are three major kinds of entities that you will likely be selecting from for your new business venture; a Limited Liability Company (LLC); a C-Corporation (C-Corp); or an S-Corporation (S-Corp). As with anything, there are pros and cons to each. Here is a quick overview of each of these entities:
> LLC
An LLC is a great choice for many small business owners. Here's why. It protects YOU the business owner from the liabilities and debts just like a C-Corp, but also provides many tax benefits. Specifically, you avoid double taxation and your net revenue is only taxed once on your individual income tax rate. We are certainly keeping our fingers crossed on how President Trump's proposed tax overhaul will affect all of us entrepreneurs. The proposed tax plan calls for a reduction of "pass thru" income tax rate from 39.5% down to a delightful 25%. For an LLC, this could be life changing for small business owners. This proposal was made by the GOP lead Congress and is something we need as Entrepreneurs.
An LLC also allows your business to grow and allows you to add additional members to your company as needed. You can also use different classes of ownership, (also called membership in an LLC), so you are able to have non-voting or non-managing members of your LLC. This allows you to build equity as you build your company. An LLC will usually act as a barrier between your personal and business assets should an issue arise. You MUST have a bank account set up for your business for this to happen and cannot combine your business and personal funds. Always remember: Thou shalt not commingle thy funds.
One potential downside of an LLC is that not all liabilities and debts actually belong to the LLC. Many young businesses get credit or loans by providing a personal guarantee for that debt. So if you're a small business owner and provide your Social Security Number and/or other personal information to get financing, you will be personally liable for that debt, even if your LLC can't pay it back. These issues can possibly be circumvented with the acquisition of an aged shelf company. Once a business entity is 2 to 3 years in age, oftentimes, credit granting companies will not require a personal guarantee from its managing members. This makes for a strong argument on the value of starting off with a Texas shelf company. Money well spent. Please search this blog on various types of business financing options to better serve you and your new business venture's needs. I have put together a detailed list of various credit granting firms to consider when building your business credit. Overall, an LLC is probably the easiest business entity to set up, manage and maintain.
Even though an LLC is not the ideal entity to use when fundraising, for many business owners, its advantages outweigh other options. For example, in an LLC, business debt generally increases the membership tax basis, which means that members can deduct more business losses on their individual tax returns. Additionally, the higher the investor or members basis, the less capital gains are possible, which translates into less tax when they sell their interest or sell the business.
> C-Corp
This is a traditional corporation, in which you can have unlimited shareholders, as well as varying classes of stock. With a C-Corp, there are unlimited fundraising options, and you can also "go public" which gives you the benefit of a limited personal liability for business activities. The downsides of a C-Corp are that all net revenues are taxed twice, which is called double taxation. The income is taxed once on the corporate level and once on the individual shareholder's tax return. Double taxation was, for many years, viewed as a sizeable burden for small business owners, which led to the formation of the LLC discussed above. I encourage all of my blog readers to consult with an attorney specializing in securities laws if this is an option you and any potential partners are seriously considering. Securities laws are shamefully complex and good counsel is necessary for the entrepreneur desiring to go down this path.
> S-Corp
Another option to choose from when forming your business is an S-Corp. An S-Corp is essentially a tax election that arises when a business elects to be taxed under "Subchapter S" or Chapter 1 of the Internal Revenue Service Code. Before electing for an S-Corp status with the IRS, you have to first have another entity for your business, called the "underlying entity." In other words, you have to start off as either a sole proprietorship, a partnership, an LLC, or a traditional C-Corp. Then, you can make the leap to the S-Corp. It is a matter of completing forms you or your CPA would submit to the IRS. You might select an S-Corp because it provides many of the same tax benefits of an LLC. An S-Corp can save a business owner a significant amount of money in self-employment taxes, while with an LLC, all revenue is subject to self-employment taxes.
Maintaining an S-Corp does take extra work as opposed to an LLC. There are several requirements you must fulfill in order to have an S-Corp status. For example, shareholders must adhere to corporate formalities, such as holding both regular and special meetings, keeping minutes of those meetings, and using a written (and format) corporate resolution to document all significant decisions made on behalf of the company. If you don't maintain these corporate formalities, it can result in an entire host of tax ramifications, some of which are significant. They include double taxation, possible back taxes, and penalties, evening being barred from using an S-Corp distinction for 5-years.
Unfortunately, what many entrepreneurs do not realize about S-Corps is that they will only see significant financial benefits if they're revenue is high enough, usually north of $1,000,000.00. Be sure to talk to your CPA before opting for this designation. As I've written before in this blog, S-Corps work well for some entrepreneurs but its not for everyone.
Some other considerations to weigh when deciding whether to use an S-Corp designation is that there are limitations on the number of shareholders allowed, and you can only issue one class of stock to these shareholders. Moreover, shareholders cannot receive special allocations of profits and losses, which could present difficulties when trying to raise capital from investors.
Should you decide that an S-Corp works best for you, one of our Texas shelf corporations can be converted into an S-Corp as it meets the IRS requirement of being an "underlying entity."
While each entity has its pros and cons, be sure to do your research and consult a CPA before making your final decision. A good rule of thumb: When in doubt, an LLC is a good choice. I am keeping a close eye on the current tax reform bill and how it will affect small business owners. Its still a long way from landing on President Trump's desk. Tax relief for U.S. businesses can only be good for this great country we call home.
Please contact me for additional information on available Texas shelf LLCs we currently have in our inventory. You can reach me as follow:
Allen T. May
cell: 214-893-2623
email: allentmay@gmail.com
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