Table of Contents
- Introduction:
- I – S Corporation:
- II – Limited Liability Company (LLC):
- III – C Corporation:
- Conclusion:
Introduction:
The decision of how to structure your company is paramount. The chosen structure directly impacts your business operations, including decision-making processes, raising capital, and, most importantly, taxation. As a prominent Silicon Valley Law Firm we face these decisions on a daily basis, and we would like to provide you with an in-depth look into three business structures – S Corps, LLCs, and C Corps.
I – S Corporation:
An S Corporation, or S Corp, denotes a specific tax designation granted by the Internal Revenue Service (IRS). This unique structure blends elements of partnerships and corporations, resulting in an appealing combination of limited liability and avoidable double taxation.
Structure:
S Corps functions under several restrictions; foremost, they are capped at 100 shareholders, all of whom must be U.S. citizens or residents. Associated shares are transferrable, but S Corps can only issue a single class of stock. All shareholders must be natural persons, meaning that one cannot hold the shares with another company. Unfortunately, since my private equity and venture capital firms invest through holding companies, they cannot invest in an S Corp. Decisions are generally overseen by a board of directors elected by shareholders, inspired by traditional corporation structures.
Taxes:
Perhaps the most attractive aspect of an S Corp is its pass-through taxation. Officers and Employees are paid salaries as W2 employees, then, any leftover corporate income is paid the the shareholders pro rata (based on their ownership) as a draw from the corporate account.
The S corporation tax advantage is the self-employment tax savings. The shareholder-employees must pay their salaries via W2 with withholding for Social Security and Medicare. However, any company profits flow to the shareholders without employment taxes.
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The advantage of the S Corp over the Self-Employment tax is dramatic.
While the entity itself pays no federal taxes, income, and losses are passed directly onto the shareholders who then report these on their individual tax returns. This avoids the notorious double taxation often associated with mainstream corporations.
II – Limited Liability Company (LLC):
An LLC is a popular choice for small to medium-sized businesses due to its operational flexibility and salient feature of limited liability protection.
Structure:
An LLC combines the structures of a partnership and a corporation. It is owned by members who may operate the business directly or hire managers for the task. In an LLC’s flexible management structure, there are no restrictions on the number or type of owners, affording greater operational freedom.
Taxes:
Unlike S Corp, an LLC has more flexibility in its federal tax obligations. It can choose to be taxed as a sole proprietorship (for single-member LLC), partnership (for multi-member LLC), or corporation. By default, LLCs are treated as pass-through entities for tax purposes, thus avoiding double taxation. In order to be taxed as a pass-through entity all owners must be U.S. citizens or residents.
III – C Corporation:
C Corporations, or C Corps, are the standard corporation type and are often used by businesses planning substantial growth or public trading.
Structure:
C Corps exist as standalone entities, separate from their founders or shareholders. They can have unlimited shareholders and issue multiple classes of stock, opening opportunities for attracting numerous investors. The decision-making level is bifurcated into shareholders, who elect a board of directors, and the board, who then appoint officers to look after the day-to-day operations.
Taxes:
Having a separate legal identity, C Corps are subjected to corporate income tax. Their profits are taxed once at the corporate level and again at an individual level if distributed as dividends. This phenomenon, known as double taxation, is a unique trait of C Corps.
Conclusion:
Choosing between an S Corp, LLC, or a C Corp can be overwhelming. Each brings a unique blend of characteristics that cater to specific business needs. In making your choice, consider your business’s size, goals, selling shares, various legal obligations, and implications for taxes. By understanding these intricacies, you can make an informed decision to maximize your company’s success.
Welcome to SutterLegal.com, a prominent business law firm in California, where our team of dedicated professionals is always ready to help you navigate complicated business laws, giving your business the strong foundation it deserves. From starting a new business to meeting compliance standards, we can guide you every step of the way.
