The success of your business begins with forming the right entity. But determining which type of entity is right for you can be complicated. There’s no one right answer. The best way to determine which type of business entity best serves your needs is to consult an experienced business lawyer before you make any decisions.
Overview
This article focuses on three types of entities: LLCs, S-Corps, and C-Corps. However, these aren’t the only ways to set up a business entity. For example, some individuals choose to operate as sole proprietorships, and some businesses are formed as partnerships. A partnership may be general or limited and may or may not limit the partners’ personal liability. There are also specialized options for certain types of entities, such as non-profit corporations and public benefit corporations.
This article will cover:
- Key considerations in choosing how to structure your business
- Protecting yourself against personal liability
- Costs and administrative requirements
- Tax consequences of different types of entities
- How entity type impacts investment
- The pros and cons of LLCs, S-Corps, and C-Corps
Key Considerations in Choosing the Best Type of Entity for Your Business
Every business is different and will have its own unique considerations. But some are common to all businesses. When choosing the right type of entity for your business, you’ll need to consider the following.
Limitations on Personal Liability
When you operate as a sole proprietorship, the proprietor and the business are legally the same entity. That means there’s no division of liabilities. A business loan is fully collectible against the proprietor of the business, and business assets can be attached to pay the proprietor’s personal obligations. Partnerships operate similarly and can be even riskier, since each partner may be personally liable for the partnership’s actions, even if they had no part in the decision.
LLCs, S-Corps, and C-Corps all provide some protection against personal liability, described in greater detail below.
Administrative Complexity and Cost
There are expenses and paperwork associated with creating and operating an LLC, an S-Corp, or a C-Corp. Unsurprisingly, costs and complexity of filings and other regulatory obligations increase with the complexity of the entity you’re creating. Some types of entities also have more complex regulations, meaning you will likely need legal and financial professionals to ensure that you comply.
Tax Liability
The structure of your business entity impacts both whether and how the entity itself is taxed and how members or shareholders are taxed. Deductible business expenses may also vary by type of entity. The difference in tax obligations can be significant, so it’s important to fully understand the tax structure associated with each type of entity before making your choice.
Investment Opportunities
Not every business is seeking outside capital, so this isn’t a key consideration for everyone. But if you are looking for investors or believe you may need a capital infusion in the future, that can be a key factor in your decision-making. Some entities are more difficult and less attractive for investors, and others may limit investment opportunities.
All About Business Entities
Florida LLCs
An LLC is the simplest form of business entity you can create outside of a sole proprietorship or general partnership. That is, it’s the least complicated way to get protection from personal liability for business debts. LLCs don’t issue shares, and the entity is free to create membership classes with different rights and preferences. Here are the key pros and cons of an LLC:
- LLCs offer protection from personal liability for business debts, and can also protect your business from your personal obligations. However, that protection is only as good as your processes. You must keep your LLC completely separate from your personal assets and expenditures to maintain the legal separation. Members may also be personally liable in certain other limited circumstances, such as fraud. A member is also personally liable if they have signed a personal guarantee, which is often requested by creditors when a business is starting up.
- LLC formation requires filing Articles of Organization with the state. Preparing your Articles of Organization will require some additional decisions, such as whether the members will manage the LLC or appoint a separate manager. Still, the paperwork is simpler than forming a corporation. There is a small fee when you file your Articles of Organization. There are also fees required when the LLC files its annual report each year.
- LLCs are disregarded entities for federal tax purposes. That means your LLC’s income will be attributable to you personally and will be reported on your personal tax returns. You’ll use Schedule C to show your business’s revenues and deductible expenses, just as you would if it were a sole proprietorship. The business itself pays no taxes unless you have opted to be taxed as an S-Corp.
- Outside investment can be difficult with an LLC. There are several reasons it’s harder to get and manage investments with LLCs, including that the LLC tax structure may require an investor-member to pay taxes on profits to the LLC that they haven’t actually received.
In a nutshell, LLCs are simpler and easier to manage than corporations, and less expensive to create and maintain. However, an LLC is typically not the best entity for growth and change. Selling an interest in an LLC and changing membership are two separate processes, and when membership changes, you’ll have to file amended Articles of Organization and update your operating agreement. A Florida LLC is also dissolved if the entity goes 90 days with no members (unlike a corporation, which is perpetual even if there are no shareholders). And you can generally expect to have a tougher time raising investment capital if you need it.
Florida S-Corps
An S-Corp is a corporation, but a simpler form than a C-Corp, and with more limitations. An S-Corp can’t have more than 100 shareholders and may issue only one class of stock. There are also limitations on the types of entities that can hold stock. Within these limitations and any outlined in the Articles of Incorporation, shares are transferable.
- Like LLC members, shareholders in an S-Corp are generally not personally liable for the business’s debts or obligations. However, they may be personally liable if the separation between the shareholder and the corporation is blurred, such as by mingling funds. They may also be liable for fraud or other personal wrongdoing, or if they have offered a personal guarantee.
- S-Corp formation requires filing of Articles of Incorporation with the state. You must also provide additional information, such as the number of shares your corporation will be authorized to issue. Your corporation will need at least one Director, and corporate bylaws passed by the Board of Directors. There are small fees associated with filing your Articles of Incorporation and filing annual reports. You must also file an election with the IRS (Form 2553) to be taxed as an S-Corp.
- S-Corps are not taxed directly, meaning that corporate profits are not taxable to the corporation. Instead, profits and losses pass through to the shareholders and are reported on their personal tax returns. Profits are taxed at the shareholder’s tax rate. This is typically beneficial for small-business shareholders whose taxable income is below $400,000 to $500,000 and who don’t qualify for the 20% Qualified Business Income (QBI) deduction.
- Investment in an S-Corp is simpler than with an LLC, because the S-Corp can issue shares. However, S-Corp investors face similar issues with the pass-through tax treatment of corporate profits, which investors may not realize.
The primary advantage of an S-Corp is that it can be used to avoid the “double dipping” that occurs when a corporation is taxed on its profits and then shareholders are taxed again on dividends. Skipping the 21% corporate tax can mean a net gain for the shareholder, but that isn’t true for everyone. The best way to determine which structure works best for tax purposes is to consult an attorney or tax professional before making any decisions.
Florida C-Corps
A C-Corp is the standard for-profit corporation. C-Corps have greater flexibility than S-Corps in many ways. For example, there is no limit on the number of shareholders a C-Corp can have, and C-Corp shares can be owned by entities that cannot be shareholders of an S-Corp. A C-Corp may also issue more than one class of stock, with different voting rights and preference levels. However, unlike S-Corps, C-Corps are always taxed on profits.
- As with other types of entities, a C-Corp shareholder is shielded from personal liability for corporate debt. However, as with other entity types, certain types of malfeasance may trigger personal liability.
- Formation of a C-Corp is very similar to the formation of an S-Corp. However, because a C-Corp is a more complex entity, planning for a C-Corp can also be more complicated. For example, at least one class of stock must have unlimited voting rights. This process is best undertaken with the assistance of an experienced business attorney.
- C-Corps pay a flat 21% income tax on their profits. Then, when some or all of the remaining profits are distributed to shareholders, those shareholders pay personal income tax on the amounts they receive. For many small and mid-sized businesses, this is a more expensive tax structure than an LLC or S-Corp.
- Investment opportunities are greatest for a C-Corp. Not only can a C-Corp issue stock to trade for capital, but the ability to create different classes of stock allows for protection of the investor’s financial interests while limiting their control over the company. Because corporate profits and dividends are taxed separately, the C-Corp investor is taxed only when they receive payouts.
While a C-Corp is typically more complex and more expensive to maintain, larger businesses and those with an eye toward growth and bringing in outside capital may benefit from the greater flexibility and the separation of corporate and personal taxation.
Starting Your Business Strong
Starting a new business can be both exciting and overwhelming. Setting yourself up for success begins with understanding the differences between LLCs, S-Corps, and C-Corps and choosing the most advantageous structure for your goals. A consultation with an experienced business formation attorney can be your best first step.
