Which type of entity should I choose?

Structuring your business as either a corporation or an LLC will get you on the best possible road to obtaining business credit. If you have not yet formed your company and you are not sure which type of entity to form, then read further.

 

If you have a sole proprietorship and aren't sure that you want to incorporate, then you should read Why Sole Proprietorships Don't Help You Build Business Credit. If you want to review entities, then you should read Details of Every Type of Entity. However, if you're like most people, you've probably narrowed the choice down to either an LLC or an S-Corp.

 

 

If you are torn between whether to form your company in your own state, or in another state, such as Nevada or Delaware, you should read The issues involved with incorporating out of your home state.

 

If you are forming your company in your own state, and are trying to decide between an S-Corp or an LLC, then the article below was written for you.

So, which one is "better" - an LLC or an S-Corp?

 

Generally speaking, an LLC is a more flexible entity.
It allows you to be more creative with how you run your business.
Many people involved in real estate acquisition and investments choose LLCs.  Also, businesses that plan to raise capital for their businesses form as an LLC, as it is easier to make an agreement to pay out of a share of the profits that is different than the percentage of ownership that you have. Let me expand on how this is helpful and how it differs from an S Corp.

In the traditional S Corp model, generally you have to stick with flowing through profits to the various partners using whatever percentage is owned.  For example, there are two owners: Pat and Chris. Pat holds 60% of the stock - and Chris owns 40%. The distributions of profit need to occur following that same split: 60% of the profit to Pat, and 40% of the profit to Chris.

 

Often, businesses that raise capital to expand, or purchase or improve assets such as real estate, bring in partners whose only contribution to the company is capital.  Sometimes, these partners don't buy into the company by truly contributing their capital and buying stock; sometimes, they only lend their money. 

 

Depending upon the situation, the owner might not want to give away a portion of the pie permanently; this is where an LLC can come in handy.  It is possible to establish classes of membership units (similar to stock), that give the financial partner a stake in the profits; but those profits are not in direct proportion to their ownership stake.  They also can be given ownership without being given control.  For example, they may have a right to a majority of the profits, but they don't have the right to outvote the other owner(s) as to decisions involving the business.

On the other hand, if you are going to be the sole owner of the company and you aren't planning on raising any capital, then an LLC may be more complex than you need.  A simple S-Corp will function quite well.

 

What about a C-Corp?

 

There are some business consultants who will recommend that a startup business go with a C-Corp structure.  The argument heard most frequently for this is that there are additional tax-write offs under a C-Corp.  This is true, and sometimes, corporations that are grossing $4 million or more per year take a closer look at the benefits involved.  Most small businesses don't want to deal with the issue of double taxation that is a reality for C-Corps.  In other words, the annual profit of the corporation gets taxed, AND then the same profits get taxed again to the shareholders.  S-Corps avoid the double taxation issue.  Specialists who recommend C-Corps often speak of trying to establish a multiple corporation strategy, and promote the idea of trying to drain the main C-Corp of its profits in order to avoid the double taxation issue.  These issues, and a study of the benefits and drawbacks of the C-Corp, go way beyond the scope of this article; if you are considering going the C-Corp route, you should consult more than one qualified professional before making your decision.

Disclaimer: This article is meant for general knowledge and is not to be construed as legal or tax advice - for specific advice on your situation, please consult a qualified attorney or tax professional.