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How to
Incorporate Your Business and Why…
Today’s pathway to
business success includes incorporation. Incorporation gives you pride and
credibility and helps you organize your business. As an incorporated
entity, you signal the world you’re serious about your business and you’re
committed to making serving your target market and customers. A corporate
entity can help you build your brand and position your company for growth.
Investors and lenders typically want to invest/lend money to incorporated
businesses rather than individuals.
Equally and often more important, a corporate entity can help protect
yourself and your assets from liability—that’s crucial in today’s
litigious society. In addition, businesses are entitled to take advantage
of certain tax benefits and conducting your business through a corporation
has been shown to reduce the risk of IRS audit.
Three Forms of Corporate Entities to consider
Today there are three primary forms of corporate entities: the
C-Corporation (also called C-Corp.), the S-Corporation (S-Corp.) and the
relatively new Limited Liability Company (LLC).
While choosing the best entity for you can seem confusing, The Small Business Advisors will handle the entire process for you.
There are three main types of entities:
• S-Corporation or “S-Corp.”
• C-Corporation or “C-Corp.,” and
• Limited Liability Company or “LLC.”
The ‘S’ and ‘C’ in S-Corp. and C-Corp.,
respectively, refer to chapters in the Internal Revenue Code or “IRC.” Now
that you have the lingo, let’s explore each type of entity.
C-Corporation or
C-Corp.
Typically, companies that trade on an
organized stock exchange are C-Corporations. Stockholders own a
C-Corporation and there are no limits on the number of shareholders. For
example, Microsoft has millions of shareholders and for a company like
this, shareholders have a high level of liquidity, for example they can
buy and sell shares of stock easily. The corporation can also borrow
money without the loan itself impacting the shareholders. Of course, if
the company loses money the shareholders can lose the value of their
investment. A C-Corp. is considered to be a “separate person” legally
and for income tax purposes. This means that in almost all cases the
individual owners cannot be held liable for the actions of the
corporation or its management.
Advantages of C-Corp.: The C-Corporation has an unlimited life,
separate from the illness or death of any owners. In other words, when
the founders or even a major or controlling shareholder dies, the
Corporation’s existence continues.
Disadvantages of C-Corp.: Like most things, there are several
disadvantages to C-Corporations. The main one is “Double Taxation.” This
means that the corporation is taxed on its profits (sales revenue minus
expenses) and then when it pays dividends (distributions to its owners)
the dividends are considered to be a distribution of after-tax profits;
the corporation does not receive a tax deduction for dividends it
declares while the recipients typically are liable for income taxes on
dividends received. In other words both the corporation pays tax on its
earnings and the shareholders pay income on dividends they receive,
hence double taxation. Another consideration is that recordkeeping can
be more involved for a C-Corp. than other forms of entities.
S-Corporation or S-Corp.
An S-Corporation is a corporation that
stands alone from its owners for liability purposes but is also known as
a “pass through entity” for income taxes. Unlike the C-Corp., the
S-Corp. does not pay income taxes on its profits but rather passes
through those profits to its shareholders. Each shareholder reports his
or her share of the S-Corp.’s income and losses on his/her individual
income tax return.
The S-Corporation is owned by a limited number of stockholders
(typically a maximum 75 but this can vary by State). S-Corp. stock is
easily transferable and can be sold to raise capital but must be within
IRS guidelines. Like the C-Corp., the S-Corporation has an unlimited
life, separate from the illness or death of any owners.
Advantages of S-Corp.: The main advantages to S-Corporations
include limited personal liability for the S-Corp.’s debts and no
taxation of profits to the corporation since the profits are taxed at
the individual taxpayer level. S-Corporations prepare an information tax
return known as a Form 1120S and a Form K-1 for each shareholder. For
example, if there are 10 individuals who own equal stakes in the XYZ
S-Corp., and the S-Corp. earns a profit of $1,000,000 this year, each
shareholder would receive a K-1 that allocates 10% of the
S-Corporation’s income (profit) to him/her, or $100,000 (10% of
$1,000,000). The S-Corp. owners may receive some income tax deductions
for certain business expenses.
Disadvantages of S-Corp.: The main disadvantages to S-Corps.
include the fact that it an S-Corp. must distribute its income to the
shareholders in accordance with the owners’ ownership interests. While
an S-Corp. is typically less complicated to run than a C-Corp., an
S-Corp. is typically more complicated to run and manage than an LLC.
Limited Liability Company or LLC
A Limited Liability Company or LLC is
similar in many ways to an S-Corp., but the LLC is more flexible and
faces fewer rules and regulations. Each LLC member (owner) pays income
taxes on his/her share of the LLC’s profits at his/her own individual
tax rate. For this reason, the LLC is also a “pass through entity”
similar to an S-Corp.
LLCs must file an operating agreement with the Secretary of State in the
State in which they establish their LLC. The operating agreement
explains the management and guidelines of the corporation. The operating
agreement governs raising capital, transfer and selling of shares. Each
State sets different requirements so be sure to engage professional
advisers.
LLCs do not issue shares of stock; instead the LLC issues member units
or interests that represent ownership. However, LLC owners benefit from
limited personal liability for company debts as with the C-Corp. and the
S-Corp. If the company is sued, only business assets, not members’
personal assets, are at risk. Members can sell or transfer their
interest(s); however, any sale or transfer is subject to any
restrictions that may be in the operating agreement.
Advantages of LLC: First, LLCs offer limited personal liability
for the LLC’s debts. There is no taxation at the corporate level, no
double taxation. LLCs are not typically limited in the number of members
the entity can have. LLCs are easier to manage and require less
paperwork than the S-Corp. and C-Corp. LLCs offer a relatively high
level of flexibility in company structure and management.
Disadvantages of LLC: It is typically more difficult to transfer
ownership of an LLC than with an S-Corporation or C-Corporation. And, as
the newest business structure, there are fewer laws governing the LLC’s
management, operation and maintenance; and fewer established precedents
exist.
There are numerous sound reasons to select a
particular form of corporate entity, but once you decide to launch your
business, it’s often prudent to incorporate your business. Incorporating
offers many benefits and opportunities, including branding and capital
raising And of course, protecting yourself and your family from liability:
limited liability.
At The Small Business Advisors, our Team of Incorporation Specialists is
waiting for your call. We have over 35 years of business and corporate
experience and look forward to helping you launch your business and
achieve the success you desire.
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