Incorporating Your Business (Sponsor)
Taking the Long View with Your Small Business
Taking the long view is a key ingredient to the long-term success of any business. But as a startup company, you may find yourself focusing on getting up and running instead of looking at the future. A key element in long-term success is taking a look at how your products and services will evolve, as well as keeping an eye on the competition.
But there’s another facet to your small business that needs attention: business formation — often referred to as incorporation. Today, we’ll overview two types of business formations — Limited Liability Companies (LLCs) and S corporations (S corps). We’ll focus on your company’s long-term vision, and how your decisions regarding business formation can affect you — both personally and professionally. Let’s start off at the beginning …
Forming a Sole Proprietorship or General Partnership
If you’re a one man or one woman operation, your company instantly becomes a sole proprietorship as soon as you make revenue. The same is true if you’re a general partnership, which is a company that has more than one owner.
The Benefits: In both instances, your company can conduct business, make a profit, deduct expenses and file your business tax return as part of your personal return.
The Downside: The greatest pitfall to running a business as a sole proprietorship or general partnership is that you have no limited liability protection.
What is Limited Liability Protection?
In a nutshell, limited liability protection shields a business owner against being held personally responsible for their company’s debts and liabilities. With limited liability protection, creditors cannot pursue the personal assets (home, savings, etc.) of the business owner to pay off business debts.
As a sole proprietorship or general partnership, owners and their business are legally considered the same – leaving personal assets vulnerable.
Since this is obviously not a good thing, what’s a small business owner to do? Two of the most popular options are forming a Limited Liability Company (LLC), or an S corporation (S corp).
What is a Limited Liability Company (LLC)?
As the name implies, when you form an LLC, your company enjoys limited liability protection. This is the most popular business formation choice for small businesses owners because of its ease of operation and the fact that it is relatively inexpensive to form.
Other benefits include limited compliance requirements and a flexible management structure, as compared to S corp and C corp formations.
Over time, you might find that the next logical step in the progression of your business is to elect S corp status for your LLC. The reason why some LLCs do this is simple …
If your LLC operates an active trade or business, and payroll taxes (SECA taxes) on the owner or owners are high, you may find that an S corporation election is your best choice.
The Differences Between LLCs and S Corps
Although these two formations share some key benefits, including limited liability protection and pass-through taxation, there are also some important differences.
- LLCs can have an unlimited number of members, while S corps can have no more than 100 shareholders (owners)
- Non-U.S. citizens/residents can be members of LLCs. S corps may not have non-U.S. citizens/residents as shareholders
- S corporations cannot be owned by C corporations, other S corporations, LLCs, partnerships or many trusts. This is not the case for LLCs
- S corporations face more extensive ongoing internal formalities. LLCs are recommended, but not
- Owners of an LLC can choose to have members (owners) or managers manage the LLC. S corps have directors and officers
- S corporation stock is freely transferable, as long as IRS ownership restrictions are met. LLC membership interest (ownership) is typically not freely transferable — approval from other members is often required
Although you might want to leave the taxes to your accountant — who by the way is an excellent resource to discuss formations with — knowing which business formation will grant you the best tax breaks could save you thousands of dollars.
No matter which business formation you choose, it’s important to have a crystal clear understanding of each option to make sure it’s the very best choice for you — both today and down the road.
About the guest blogger: Joey Donovan Guido is the writer of BizFilings blog, Time to Start Up! The blog is a resource for small businesses, offering support and insight into running a successful company. He also has a blog called Daddy Brain that takes a look into the thoughts, feelings and struggles of being a modern-day dad.