Choosing the right corporate structure — LLC, “S” Corp or something else — for your company is a complicated issue, and one that you should discuss with an attorney. What’s a deciding factor for one business may be wholly unimportant to the next, so don’t base your decision on what other companies have done, or what your Uncle Al did. Take your time and speak with your business partners and a legal professional before making a decision.
The most common corporate structure for a small or start-up business is the LLC. That’s because it’s relatively simple to set up and manage and it is more flexible, enabling you to make modifications as your business grows.
In a traditional corporation, the decision-making process is divided between directors and officers, who each have separate and distinct responsibilities. Corporations typically have bylaws that require decisions to be made by a certain number of shareholders and/or directors during formal meetings, while LLCs are often better able to make decisions on the fly and with fewer formalities.
LLCs are also taxed in a way that many view as simple and easy to understand when compared to the often-complicated world of corporate taxation. An LLC is not taxed as a stand-alone corporate entity. Rather, the members of the LLC report losses and profits on their own personal returns; for this reason, an LLC is called a “pass-through entity” (since losses and profits “pass through” to the members). That said, an LLC can also elect to be taxed as a corporation, allowing additional flexibility for members.
The “C” Corp
The corporation — sometimes called a “C” corp — is the tried-and-true, more traditional business structure. Its more formal structure and established rules are seen as more predictable for some types of business.
A traditional corporation may be preferable if your company is planning to seek investors, especially from larger venture capital firms or “angel” investors. Many investors prefer a corporation structure to an LLC due to taxation concerns – and some investors will only invest in a corporation.
Additionally, certain “fringe benefit” plans – such as some stock option and retirement plans – are available only to corporations. These incentives can prove powerful draws for new employees, especially if your company doesn’t yet have the money to pay them a competitive salary. It’s also easier to offer stock to your employees in a “C” corp.
However, those concerns may be a few years down the road. It’s often better to start out as an LLC and convert to a more formal structure later as the business grows and its needs change.
The “S” Corp
You will often hear that an “S” corp is the best structure for a smaller businmess. While that may be true for some businesses, it’s not always the case. The most outstanding feature of a subchapter S corporation is that it can only issue one “class” of shares (which will be a problem for many investors), and because it cannot have nonresident aliens as shareholders.
If that works for you, then an “S” corp may make sense. Its big advantage is that, somewhat like an LLC, a “S” is a “pass-through entity” — losses and profits pass through to the owners’ personal tax returns. A “C” corporation, by contrast, is its own entity, and pays taxes at the corporate level. If owners are paid dividends, there is the possibility of double taxation since theoretically the corporation will pay tax on the income, and owners will then pay income on the dividends.
An important note is that an LLC can also elect to be taxed as an S-corp. This may seem strange given that both are pass-through entities, but the S-corp offers some tax planning perks that you don’t get with a standard LLC. So if your CPA says that you simply must have an S-corp, but you don’t want to deal with appointing a board or holding regular meetings, an LLC taxed as an S-corp may be a good option.