Should you operate out of the home or at an office? How many employees do you hire at first? How much will you be able to sell?
There are a lot of questions entrepreneurs need to ask themselves before getting their business off the ground, but one of the first and most important is how they choose to incorporate their business. There are different legal options for how they register the company with state authorities, and different designations come with different benefits and regulations. Two of the most popular designations—limited liability companies and corporations—each have advantages and disadvantages depending on what the company’s founders want to achieve.
Limited liability companies, or LLCs as they are commonly known, are a popular choice because of the protection and benefits they give to owners. The limited liability part of the name means that owners—or members, as they are called—do not have personal responsibility for lawsuits against the company or possibly bankruptcies. Limited liability companies also come with some tax benefits, like avoiding state and federal taxes and instead having members pay taxes directly through their personal income taxes. This also means that if the company suffers a loss, members can use that as a tax write-off.
This is also seen as one of the easier companies to establish. It requires only a brief form with the name of the company and names of the members, and most states have only a small fee for starting it up. Though experts say it is a good idea to have an accountant or attorney to help with these forms, and with setting up the procedures for the company like how it would dissolve and how profits are split, states keep the forms simple enough that members can do it by themselves. After the company has been established, most states have minimal annual fees as well.
Similar to the LLC in some ways, the S corporation is also a popular choice for business classification. Like limited liability companies, S corporations pass income—and the taxes that come with it—through to shareholders. So while it is classified as a corporation under the law of the state where it is incorporated, an S corporation is treated more like a partnership with it comes to taxes. This type of business is also able to avoid other types of taxes, like personal holding company tax and the alternative minimum tax. On the flip side it also excludes certain types of deductions, like ones for dividends received or certain charity donations.
The legal issues surrounding S corporations are considerably clearer than that of LLCs. The corporation has existed as a business classification for centuries, and many of the rules and regulations have been tested legally and precedence established through many court cases. Limited liability companies, by contrast, are relatively new inventions. Though they were first created more than 100 years ago in Germany, limited liability companies did not make it to the United States until the 1970s. As a result some of the legal aspects of limited liability companies have not yet been challenged in court, so there are some things that could change regarding regulations.
S corporations also have different and more stringent requirements than limited liability companies. While there are few restrictions on what kind of business can become an LLC, with really only banks and insurance companies forbidden, S corporations have a higher threshold to meet. These companies must be an eligible entity, which can include a LLC or a domestic corporation, and choose to be taxed as a corporation. They also must have fewer than 100 shareholders and must be U.S. citizens or residents. The members of a limited liability company do not even need to be actual people, but can instead be foreign entities, corporations or even other existing LLCs.
Companies that do not maintain the regulations to be an S corporation can lose their status and be reverted back to the default C corporation level. This happens if the company grows to more than 100 stockholders or if any shared are sold to a non-U.S. resident. There are also income restrictions that can disqualify a company for having S corporation status. If the company earns more than 25 percent of its gross receipts through passive income for three consecutive years in which it has earnings or profits, then it loses its status and reverts to a C corporation.
If you want to learn more about LLCs or are interested in how to complete forms to get one started, you can find more information at LLC.org.
If you’ve ever read the business section of the newspaper you probably noticed the letters at the end of a company’s name. It might be Co., Corp. or LLC, but though they may seem insignificant these little letters tell a lot about what the company does and how it is regulated.
Before a business can begin operation it must register with the proper authority in its state, and when doing so the founders have a range of options depending on their goals and what the company will look like. Two of the most common options, limited liability companies and C corporations, vary drastically in some of the benefits they offer and how the organizations are taxed, but also have similarities in their setup.
A limited liability company is one that keeps its owners somewhat protected against the potential hazards that come with running the business. They are not on the hook if the company is sued or goes into bankruptcy proceedings, and are also able to benefit from the looser tax structure of the LLC. The company does not pay federal or state taxes on its revenue, but instead this is taxed by the individual members through their personal income tax. If the company sustains losses for the year, the member still benefit by being able to write the losses off on their income tax forms.
With C corporations, the company is taxed separately from its owners. The exact taxes are determined by the amount of taxable income it had in the particular year. C corporations that make up to $50,000 are taxed at 15 percent, and have no other fees to pay. Anything over this amount is subject to higher tax rates along with fees, up to the point that a C corporation making more than $15 million each year pays 38 percent on all profits over that $15 million threshold. It also would pay $5.15 million in additional taxes.
Limited liability companies and C corporations do have some similarities in their setup. An LLC can be formed by an individual, group of individuals or even an existing corporation or LLC. The restrictions expand beyond the borders of the United States, allowing foreign entities to start LLCs. C corporations are also regulated loosely in who can form them. Unlike S corporations, which must have fewer than 100 shareholders and have its owners based in the United States, a C corporation can have any amount of shareholders, foreign or domestic.
Both LLCs and C corporations are also relatively cheap to start. Members of a limited liability company must fill out forms known as “articles of organization” that include the name of the company, the names of members and some basic information about its procedures. Fees for submitting this form vary by state but are generally $50 or less. The cost for starting a C corporation is a bit higher and the paperwork greater, but the process is just as streamlined. Owners generally pay around $100 for the process, and can fill out the paperwork online.
These C corporations do have a bit tighter requirements, as regulations stipulate that they have at lease one director and two officers. Business experts also strongly suggest that owners of a C corporation consult with an attorney during the setup process to make sure all requirements are met, while members of a limited liability company are better able to handle this step themselves. Those interested in starting a limited liability company can even find information and forms at LLC.org.
It is common for business owners to start as an LLC in the company’s start-up phase, when the company is not yet making money. Limited liability companies do not have requirements to hold meetings or draw up resolutions as corporations do, making it easier to run, and the losses can be filtered on to members. But as businesses grow and profits increase, they often switch to C corporations so some of the profit can be protected from taxation.
C corporations also offer some benefits not available with limited liability companies. These corporations are able to gain greater financing by going public and trading on a national exchange. They also have more options to receive private investments, as angel investors and venture capitalists are more attracted to the flexible ownership options that C corporations can offer. Offering medical reimbursement benefits is easier in a C corporation, which can deduct medical payments up to a dollar amount of its choosing.
Limited liability companies are a little like the new kid on the block. Everyone wants to get to know them and be their friend, even if they don’t quite know everything about them yet.
Compared to corporations or partnerships, LLCs are relatively new to the business world. But despite some gray areas that surround legal obligations and regulations for this classification of business, limited liability companies have grown increasingly popular. This comes in large part because of the benefits LLCs offer—they are easier to run and maintain, cheaper to start and give some tax and income advantages. They have grown especially popular during the economic downturn, as pressures on businesses have mounted and available start-up funding became harder to find. Between 2008 and 2009, the recession’s most severe years, the number of LLCs founded jumped 12 percent.
One of the biggest advantages of a limited liability company is the easy and money-saving tax situation it provides its owners, who are referred to as members. But to better understand these benefits and why they work so well, it’s best to take a step back and a closer look at the LLC itself.
The idea of a company where the owners have limited personal liability for its actions is not a new one, at least not in the United States. It was founded just before the turn of the 20th century in Germany, and over the next few decades spread to other nations in Europe and eventually Latin America as well. Though it came to America in other forms around this time, it was not until Wyoming officially authorized it in the 1970s that LLCs in their current form were an option for American business owners.
They gained popularity for the limited liability placed on members, meaning they could not face lawsuits or be affected by the company’s bankruptcy the way owners in a partnership could. Limited liability companies are also popular because of their hybrid nature, taking some of the most attractive aspects of corporations and partnerships while also avoiding some of the hassles of these businesses. Members don’t have to hold meetings they way corporations do, pay less in fees to get the business started and can use the classification for a range of different business types. LLCs can even be formed by foreign entities or corporations, taking the legal protections and benefits of these organizations.
But when it comes to the benefits that limited liability companies offer, the tax situations is one of the top. What sets LLCs apart from S corporations or C corporations is that the members of an LLC only pay taxes once on their profits. For corporations, any profits are subject to corporate taxes before they can be turned over to owners as income. This is known as double taxation, but it’s actually more than that because the corporate taxes are paid to the federal government as well as local or state governments. But with limited liability companies, taxes on the profits are paid directly by the members through their personal income taxes. Even if the company doesn’t turn a profit, members can still benefit from the tax situation—they are able to write off any LLC-related losses on their personal income taxes.
The taxes and fees associated with starting an LLC are also less than their counterparts in partnerships, sole proprietorships or corporations. Starting a limited liability company involved simply filling out a form known as “articles of organization” and filing it with the proper state authority. This document spells out voting rights, the responsibilities of the owners and some procedures into how other members could be brought in or how the company could one day be dissolved. Though some experts suggest hiring an attorney to complete this form, most states keep it self-evident enough for anyone to fill it out, and states also limit the cost to around $50. Many states, including Washington, even have online options for people looking to register their limited liability companies.
Taxes remain low and administration stays easy even after this start-up period. The annual fees for LLCs are generally lower than those of corporations, and the annual regulatory requirements are much easier. There are some limitations to the tax advantages LLCs can offer, as well as limits to the liability itself, so business experts suggest studying the applicable state laws closely or consulting with an attorney. Those interested in finding out more about how limited liability companies work or who would like to find forms on how to start one can find them at LLC.org.