When first starting your business two of the most popular business entities for entrepreneurs are S-Corps & LLCs this post will focus on the pros & cons of both.
• Eliminating double taxation: In an S corporation, profits and losses are passed through to shareholders, and taxes are only paid once. Check with your secretary of state to see how S Corporations are handled. Some states do not recognize S Corporations and will tax them as a regular C Corporation. Also some states charge S Corporations a state tax, although the corporation will not have to pay federal tax.
• Protection from liability: As the owner of an S Corporation, your personal assets are separate from the business’s assets and are therefore protected in case any judgments occur against the business.
• More room for investors: S Corporations can have up to 100 shareholders but no more than that.
Easier accounting rules: S Corporations without any inventory can use the cash method of accounting, which is much simpler than the accrual method. Check with your accountant about which option makes sense for your business. If you do not have an accountant get one as soon as you can.
• Rules and fees: Like a C Corporation, S Corporations are required to file a number of official state and federal documents, including Articles of Incorporation and corporate minutes. They must also hold regular shareholder meetings and pay the required government fees. If you are the lone shareholder you are still required to have a shareholder meeting with documentation!
• Shareholder restrictions: Realize that if an S Corporation has shareholders, the shareholders will be taxed for any income the company has, even if they did not receive any portion of that income. (In a C Corporation, shareholders are taxed only if they receive dividends.) In addition, S Corporations are only allowed to issue one class of stock, which may discourage some investors.
• Salary requirements: The Internal Revenue Service (IRS) requires all officers and owners of an S Corporation to make a salary, even if the company is not yet making a profit. This could be problematic for new businesses struggling to make payroll. A “reasonable salary” is what a person with the appropriate skills needed for the position would be paid on the free market.
• More flexibility: Although a limited liability company must file articles of organization with the state, it has a more flexible management structure than a corporation. The flexibility evolves from the phrase “unless otherwise provided for in the operating agreement.” This allows business owners to create a structure tailored to the business owner’s requirements.
• Limited liability: As its title suggests, the LLC protects owners and shareholders from personal liability in case of judgments or debts against the business.
• Tax options: An LLC can choose whether it wants to be taxed as a sole proprietorship, partnership, S-Corporation, or C-Corporation.
• Fewer compliance issues: In most states, an LLC doesn’t need to have an annual meeting, and the LLC isn’t required to have a board of directors. Plus, there’s less paperwork and recordkeeping required compared to a corporation.
• Perpetual existence: Like a corporation, an LLC has a life of its own and can continue to exist after the owners sell their shares or die.
Investors, much like a limited partnership, members of an LLC can be investors only and have little or no say in the daily operation decisions of the business, as long as this is stated in the operating agreement.
• Pass-through taxes: Although LLCs do not deal with the “double taxation” faced by a corporation, they do incur “pass-through” taxation, meaning that profits and losses are reported on each owner’s or shareholder’s individual tax return, whether or not the shareholders receive dividends. Because of that, the LLC may be more suited to a one-person owner situation, as shareholders may not appreciate pass-through taxation.
• Raising money: Because of the lack of a strict corporate structure and the pass-through taxation, investors may be hesitant about putting their money into an LLC.
• Additional taxes: Many states, such as California, New York, and Texas, to name a few, require LLCs to pay a franchise tax or “capital values tax.”
Less structure: The lack of strict requirements for governing the business could mean problems down the road unless a detailed operating agreement is in place, which requires additional upfront costs such as attorney fees.
All of the above is a summarized description for both business entities. There are multiple other options (Sole proprietorship, Partnerships, Limited Liability Partnerships, etc) I chose to focus on these two however because they are most attractive to start up entrepreneurs starting from the bottom. For your convenience I have included this LINK that will direct you to the contact info for your Secretary of State office. Once you have the contact info reach out to them directly for any questions on incorporaton fees, and required paperwork to file, every state is different. Please keep in mind I am NOT a lawyer and Mogul Motivation is NOT a law firm. These are just facts I learned throughout the years on my entrepreneurial journey. You should also talk with a professional consel before making any decision in regards to your business. Thanks for reading and I hope this helps!