When you’re creating a new business, it’s not outlandish to say that you need to decide on what type of business it will be. This isn’t in regards to what industry your business will be in, or what product or service you offer. In the United States, each business has a strategic entity formation, where they decide what type of company the market and the government will recognize them as. In the U.S., there are three types of businesses one can be: C-corporation, S-corporation, and Limited Liability Company (LLC).
Depending on the size and tax bracket of your business, you may not qualify for all of the three. This limits your options, but you have to make sure you file under the right category come tax season. If you’re not properly operating your business under the correct labels and conditions, you can pay more or less than you should in taxes. Either way, that’s bad for your business. That’s why having an entrepreneurial law attorney is important to have, especially during the strategic entity formation process.
This is the most common type of business in the U.S. and is considered the default type by the IRS when you form a business. A C-corporation has several features that govern how it operates day-to-day and the structure with which it operates.
These features lead to there being more options for a C-corporation to raise capital and financing, such as equity financing. When considering what business type to file under, C-Corporations are a safe bet. And because it is the default, there are no restrictions a business needs to become one, unlike the other two types.
The classification of S-corporation is a spin-off of the C-corporation in many ways. They contain many similarities in their structure, both offering limited liability protection in their strategic entity formation. With limited liability protection, shareholders are rarely personally responsible for the debts and liabilities a company takes on.
This means the main difference between the two is their tax structure. This leads to several restrictions on S-corporations that C-corporations don’t have. S-corporations are pass-through taxation entities. Rather than be double taxed like in a C-corporation, S-corporations file an informational federal return. By doing this, no income taxes have to be paid at the corporate level because they “passed through” the business. This ends with them being reported on the shareholders’ personal tax returns, with any tax due being paid by the shareholders on the individual level.
This tax structure doesn’t affect every aspect of an S-corporation. S-corporations still follow the same structure of shareholders, directors, and officers as C-corporations; they have the same status as a separate legal entity; they have the same internal and external corporate formalities regarding adopting bylaws, issuing stock, holding shareholder meetings, filing annual reports, paying annual fees, and more.
How S-Corporation’s tax process makes it unique, is how:
An S-corporation classification is worth considering if you plan to have a lower number of wealthy shareholders, who want to avoid income tax. Considering how S-corporations can only be created by domestic businesses with less than 100 shareholders, it works well for specific kinds of businesses.
C-corporations, S-corporations, and Limited Liability Companies (LLC) all are set up to limit shareholder liability. It would be hard to get anyone to invest in a business venture if they became responsible for the business’s debts and potential lawsuits. They all limit liability under the idea that liability only extends with a person’s investment. LLCs follow this mindset more than the other two types.
Where C-corporations and S-corporations have similar paths for strategic entity formation, LLCs start completely differently. LLCs can form between one or a few business people, as owners, who create an Operating Agreement to agree on everyone’s responsibilities and ownership in the business. This contrasts to the other two types which create a whole board of directors who then have to agree on bylaws and officers.
Because LLCs are created this way, the owners are not shareholders, so much as they are individuals who have an equity interest in the business and its assets. They own portions of the day-to-day functions, where shareholders own nothing of the actual ground-level business.
Similar to S-corporations though, LLCs are pass-through businesses, where profits and losses–and therefore taxes–pass through the owners rather than the business itself. They don’t pay corporate taxes and treat their revenue like they would if they were employed by someone else. Though, unlike S-corporations, LLCs have to pay self-income taxes because they own the business.
The three types of businesses can become confusing with their many crossing similarities and differences. Depending on the business model, the answer can seem obvious, and in others, an entrepreneur may have no idea what business type fits their model best. An entrepreneurial law attorney can weed through the ideas, the business model, the revenue, and the preferred structure you’re using or aiming for with your business, to figure out what’s best for you.
We can tell you if your company has too many investors to make an LLC work, or if you have just enough to qualify for the special tax breaks of an S-corporation. Tressler & Associates has been helping businesses new and old with their strategic entity formation. We’re also capable of collecting, writing, and overseeing all the documents included with and tangentially related to creating your business.
You can’t afford to make a mistake with the creation of your business. A business’s rules, structure, paperwork, and tax filing must be airtight. One mistake can lead to the collapse and failure of the whole endeavor.
The Tennessee entrepreneurial attorneys at Tressler & Associates don’t want to see that happen. We want to see your business succeed and thrive for years to come. Contact our attorneys, and we’ll work with you to make sure your business thrives.
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