Although the prospect of starting a new business can be very exciting and potentially rewarding, there are many potentially frightening and confusing aspects of a new start-up to be addressed, researched and tackled before day one.
We can help you to obtain a Federal Tax Identification Number (EIN), fill out the necessary forms, and get you running, knowing that everything has been properly undertaken.
When starting a business, there are different types of entities to establish. The type of business you create regulates which type of income tax return you will ultimately have to file. For most businesses, the most common business establishments generally fall under one of two federal tax systems; the C-Corporation, which entails taxing both the business entity itself on the revenues it has earned and its owners from the dividends or other profits that they have received.
The second tax system refers to a pass-through taxation, also known as a flow-through entity. While the entity itself is not taxed, the business owners themselves are taxed on the entity’s income.
While each entity has its own advantages, we can provide you with the appropriate guidance to help you decide which of the two federal tax systems to use by examining your limitation of liability to guard your assets.
S AND C-CORPS
When deciding what type of business entity to form at the time when starting a company, you must choose whether to structure the company as an S-Corp or C-Corp. However, it is important to clarify the differences between the two, as it will help you choose which one will be best for you and your business tax structure. The major difference between the two is that while S-Corps are noted as “pass-through” entities, in which a business’ profits and losses are reported as part of the owner’s income, C-Corps are taxed both at the corporate level as well as on the owner’s personal income tax return (only if corporate income were to be distributed to the corporation’s shareholders as dividends).
The two most common types of partnerships in business are general and limited partnerships.
While partners in a general partnership control a company and assume responsibility for the partnership’s debts and corporate obligations, a limited partnership comprises both general and limited partners. In addition, whereby the general partners own and manage the business and concurrently assume liability for the partnership, limited partners only serve as investors, they do not oversee the company, and are not subject to the same responsibilities as the general partners.
Although there are some relatively minor differences in how general and limited partners are taxed, both types of partnerships are treated as pass-through entities.
LIMITED LIABILITY COMPANIES (LLCS)
Limited Liability Companies (LLCs) have evolved into becoming one of the most popular business forms, in that, like corporations, owners have limited personal liability. While an LLC provides management flexibility, it also offers pass-through taxation benefits and is treated as a partnership for federal tax purposes, but with greater flexibility than S-Corps.
Choosing the Tax Treatment
The IRS has enabled business owners to choose how their business entity will be federally taxed, allowing for either C-Corp or pass-through “check-the-box” treatment.
While an entity must be treated as a corporation if incorporated, partnerships and LLCs that are publicly traded must be treated as C-Corps. All other partnerships may either be taxed as C-Corps or pass-through entities.
Whereby there are important consequences from which tax treatment you choose, we can help you to decide which will best benefit you and your company by presenting and clarifying the pros and cons of the C-Corp and the pass-through “check-the-box” treatment.
Choosing the Correct Form
In choosing which form to use, you must consider which will work best for you along with the way you would like to manage your business. In helping you to make your decision, we will need to examine and compare C-Corp and pass-through entities, and then compare them with other viable choices that might be pertinent for you.
Choosing the Pass-Through Entity
If you were to choose a pass-through entity, which one should you select? The following information will explain the differences and guidelines for each entity.
S-Corporations are companies that choose to pass business income, deficits and credits along to their shareholders for federal tax reasons and are acknowledged for their business advantage over general partnerships, sole proprietorships, limited partnerships and LLCs under certain conditions.
Corporations must meet all the specific criteria in order to qualify for S-Corporation status. They must be domestic, they must be owned by U.S. citizens or permanent residents, comprise no more than 100 permissible shareholders, have only one share class of stock, and must not be an ineligible corporation.
Most notably, S-Corporations are known as “pass-through entities,” which simply mean that the business itself is not taxed. Rather, generated income and profits are reported on the business owner’s personal tax returns.
Furthermore, S-Corporations’ limitation of liability provides certain advantages over general partnerships in states that do not allow single member LLCs.
LLC’S VS S-CORPORATIONS
While both LLCs and S-Corporations are both very popular and both protect your personal assets from business debts and liabilities, there are some distinctive differences between the two that should help you to determine which business structure will best serve your needs.
In making your decision, it is important to understand the differences between LLCs and S-Corporations. Of the two types of corporations, as previously noted, the IRS is more restrictive concerning ownership for S Corporations, as LLCs have highly flexible management structures and offer flexible tax reporting options not offered with other types of business structures.
Unlike other types of business structures, as a small business owner, an LLC offers comparatively simplified record keeping, with far fewer reporting and record keeping requirements. In comparison, an S-Corporation designates the specific way a business is being taxed via the U.S. government tax code. Unlike other business entities, S-Corporations are not subject to double taxation, further noting that taxes are only filed once a year.
Even though both S-Corp and LLC owners can deduct start-up or operating losses, LLC owners have greater inherent flexibility by being able to deduct up to the share that the LLC owes the other members as opposed to S-Corporation owners, who can only deduct debt that the S-Corporation owes them.
Complicated tax adjustments, also known as basis adjustments, which are unavailable with S-Corporations, can be made by the LLC if LLC interests were to change hands or LLC property were to be distributed, thus reducing the amounts taxable to LLC members under certain conditions.
Although distribution of an appreciated LLC property to LLC members is not taxable, an equivalent distribution to S-Corporation stockholders is taxable.
Contingent on various state laws in which they do business, S-Corporations may be taxed at the entity level.
LLC’S VS PARTNERSHIPS
From a business perspective, on account of their limited liability for its members, LLCs, through their occasional special tax rules for limited partners, have specific advantages over general and limited partnerships.
The primary distinction between an LLC and a Partnership is recognized by its different liability protection. Whereby each partner has personal liability for the debts and responsibilities of a partnership, an LLC is set up to provide limited liability to its members.
LLC’S VS PROPRIETORSHIPS
Noted and well regarded for their limited liability, in comparison to Proprietorships, LLCs are often considered to be more advantageous for sole proprietors from the business standpoint, in that a sole proprietor’s liability is limited only to the amount of his or her investment in the LLC, not to mention, LLCs afford sole proprietors the added benefits of simplicity and liability protection.
Although Proprietorships are generally thought to be less costly than LLCs, unlike Proprietorships, in which a business owner remains responsible for the company’s debts and liabilities, an LLC protects business owners from debts, liabilities, creditors, and most importantly, lawsuits that may be initiated against an LLC.
Professional Practice Entities
Professional practices, such as doctors and lawyers, have a variety of choices as to their type of business entity.
Although a professional corporation provides limited liability for general business debts, it does not provide malpractice protection for the practitioner or the practitioner’s fellow practitioners in the firm, which may be managed as either C-Corporations or S-Corporations.
Although most states allow professionals to practice either under a general LLC or as a special Professional Limited Liability Company, liability is not limited to the professional’s own malpractice, but rather, depending on the state in which the professional is practicing, the liability may be limited to the malpractice of the other firm’s members or the firm’s debts, enabling shared comparative advantages and disadvantages of other LLCs.
In addition, an LLC combines the limited liability of a company with the tax benefits of a partnership.
LIMITED LIABILITY PARTNERSHIPS (LLPS)
Comprising general partnerships whose partners have limited liability, Limited Liability Partnerships (LLPs) are intended for professional practices in which a partner is liable for his or her own malpractice, but not for that of a partner’s malpractice.
SOLE PROPRIETORS AND PARTNERS
Deemed the simplest and most cost-effective way in which to start and operate a business, a sole proprietorship is not a legal entity, and although it can benefit the business owner from the operational standpoint, the owner remains personally liable for all of the debts, losses and liabilities, and can potentially expose himself or herself to potential lawsuits.
Other Pros and Cons of C-Corps
Even though it is the most costly and time consuming to start in terms of its preliminary paperwork, a C-Corporation is still very popular because of the strong liability protection and advantages it provides its owners.
Changing to Another Entity
Over time, it sometimes makes sense to convert your business entity as dictated by changes to your company. Although a significant decision, with far reaching implications, changing your business entity from one to another can be greatly advantageous and can have a significant impact on your legal and tax liabilities.
Government and Non-Profit Agencies
The Small Business Association (SBA) is a U.S. government agency whose role is to provide support to start-ups, entrepreneurs and established small businesses through the “3 Cs” of capital, contracts and counseling. The SBA has helped to deliver millions of dollars in loans, loan guarantees, business counseling and other types of assistance, and has offices located throughout the United States. You can contact the SBA through its website, www.sba.gov.
When asked why a business should incorporate, it boils down to a few noteworthy and possibly beneficial reasons for doing so.
To protect your personal assets, incorporating a business enables you as a business owner to legally limit your personal liability against business debts while also providing you with considerable tax savings through additional allowable deductible expenses and restructured retirement and tax deferred savings plans.
In contrast to sole proprietorships and partnerships, which will immediately cease to exist if a business owner were to either leave the business or die, an incorporated business will be able to continue.
Another justifiable motive for adding “Inc.” after your business name is from the marketing standpoint in that it lends credibility and legitimacy to your business and is a great cost-effective way in which to build and add awareness to your brand while growing your business.