Company structure details

The most common types of companies are:

The best choice for most entrepreneurs is an LLC or corporation, because the owners of the company cannot be held liable for any losses of the company. For example, if your business is sued for more money than it has and loses, your personal belongings can't be seized.

LLCs require very little paperwork to start and maintain, and are best suited for a small number of people starting a business who won't often add or remove owners. Corporations require more paperwork to start and yearly paperwork to maintain, and are best suited for businesses that may raise investment or otherwise change ownership.

Tax implications

All business types besides corporations are "pass-through" entities: any profits or losses of the business are passed through to the individuals who own the company. So if you own 50% of your business and it makes a $200,000 profit, even if you only take $60,000 of that profit, you'll be taxed as if you took $100,000 (50% of all profit). Corporations are "double-taxed": if your business makes a $200,000 profit and you take $60,000, the corporation will pay taxes on the full $200,000, and you'll pay taxes on your $60,000 as well.

A corporation can become a pass-through entity by taking an "S election". The S election also reduces the paperwork the corporation must file. S corporations cannot have more than 100 shareholders, any non-resident alien shareholders, any other corporations or partnerships as shareholders, or multiple classes of stock.

An S corp's pass-through profit is taxed as shareholder profits, which has a lower tax rate than employment income. An LLC's pass-through profit is taxed as self-employment income, which has a higher tax rate than employment income, so many LLCs use an option to be taxed like S corps. The IRS requires that S corp owners pay themselves a reasonable salary; if they pay themselves an unreasonably low salary to try to hide their income as profits, the IRS may reclassify that profit as salary and tax it at the higher rate.

Ownership

Unlike corporations, LLCs do not have shares that can be bought and sold. Owners may be added or removed through the agreement of the existing owners, but an LLC's lack of shares limits its growth and investment possibilities. While a company can convert from an LLC to a corporation, doing so can erase its credit history, making it harder to get loans or access other financing. A company can convert from an S corporation to a regular corporation (a "C corp") without losing its credit history.

Final thoughts

LLCs that elect to be taxed as S corps are very similar to regular old S corps. LLCs have the advantage of slightly less paperwork, and S corps have the advantages of greater investment potential and ease of changing owners. If you're not sure, we recommend you start an S corp, because the additional paperwork is minimal, and it doesn't constrain your ownership changes or investment.

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