  Which Entity?
S Corp vs. C Corp
LLC vs. Corporation
Which Entity?
If the decision is to establish an entity, the next question
is what type of entity. The usual choices are a corporation
or limited liability company. Both types of entities can
have one or many owners. Owners of corporations are called “shareholders”.
Owners of limited liability companies are called “members”.
The selection of a C corporation
is common with companies that expect to seek
venture financing.
Institutional investors cannot be shareholders
of S corporations. Venture investors often want
preferred stock, which an S corporation cannot
issue. |
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Both corporations and limited liability companies can be taxed
at the entity level or they can be pass-through entities, which
means that the profits or losses will pass through to the individual
tax returns of the owners. A corporation is normally taxed
as an entity, although it can elect to be a pass-through entity
under subchapter S of the Internal Revenue Code. A corporation
that does not file for subchapter S status is referred to as
a “C” corporation.
S Corp vs. C Corp
The S or C designation is a tax classification. The entity
itself is organized under the state corporation laws. From
a corporate law point of view, there is no difference between
an S and a C corporation. Limited liability companies are
pass-through entities by default, but they can file an election
with the Internal Revenue Service to be taxed like a C corporation.
Founders that want to limit their liability without incurred
double taxation, can establish either an S corporation or
a limited liability company. Often, the selection of one
of these entities is a matter of personal preference by the
lawyer, accountant or client. The differences may be minor.
In other cases, the differences may be significant. For example,
the limited liability company is the logical choice when
the company will own assets that are likely to appreciate,
such as real estate. The distribution of appreciated assets
can trigger income taxes in an S corporation that might be
avoided with a limited liability company. The limited liability
company can also distribute profits in ways other than strictly
in proportion to ownership.
A C corporation is also the
usual vehicle used by a foreign company to establish
a U.S. business.
The foreign company will typically want its U.S.
business to be taxed separately rather than as
a branch office, which might subject the foreign
entity to U.S. taxation. |
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LLC vs. Corporation
If there is no compelling reason to establish a limited
liability company, the better choice may be to establish
a corporation. The reasons are:
- limited liability operating agreements (like partnership
agreements) can be complicated.
- corporations have clearly-defined
management structures even in the absence of shareholder
agreements
(the corporate equivalent of an operating agreement
or a partnership agreement).
- it is often less expensive
to establish a corporation than a limited liability
company.
- S-corporation status provides the owner the
ability to reduce self-employment taxes
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New York requires limited liability companies to publish a
legal notice of their formation once a week for six weeks in
two newspapers in the county in which the business is located.
The company must then file a proof of publication with the
state. This can add anywhere from a few hundred to a couple
of thousand dollars to the cost of formation. In addition,
a limited liability company in New York is required to have
an operating agreement in place within 90 days after the articles
of organization have been filed. While it is a good idea for
a newly-formed corporation to have a shareholders' agreement
in place, there is no statutory requirement to have one at
all, let alone within a defined time period
All profits in a limited liability company are subject to
the self employment tax of 15.3% on an individual's first
$87,000 of net earnings from self-employment, and 2.9% of
earnings above $87,000. The shareholder of an S corporation
is subject to self-employment tax on amounts received as
compensation for services, but not on profits that automatically
pass through
Some lawyers and accountants prefer not to deal with the
corporate formalities. A corporation must have a board of
directors and officers, and it must hold annual meetings.
In fact, these formalities can be handled quite easily. On
the other hand, the subchapter S corporation does have certain
disadvantages. For example, a subchapter S corporation can
lose its subchapter S status if it fails to file its subchapter
S election at the start of any tax year, or if a shareholder
transfers his or her shares to a nonqualifying shareholder.
Also, while there is no consequence to converting a limited
liability company to a corporation, there may be tax liability
if a corporation converts to a limited liability company.
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