Organizing your entity, corporation or LLC?
As an entrepreneur, and a nurse, I knew that I had to organize my business either as a corporation (inc.), or as a limited liability company (LLC) so that I could protect my personal assets against claims. Now, I did have a couple of businesses prior, and the LLC was the type of entity that I chose. This time around I wanted to really take the time to do as much research regarding the matter, and of course weigh the pros and cons. This shouldn’t be interpreted as legal advice, and I’m not a CPA. You ultimately have to make the decision that’s best for your new business. Let’s do a very basic comparison:
The LLC may be the best option if:
You’re looking for an organization type that is for the most part, relatively easy. As an overwhelmed and budding entrepreneur, who doesn’t want easy, right? This type of entity may in fact work for most new businesses and is recognized in all 50 states. Administrative record keeping can be significantly less, typically there’s no requirement for an annual meeting for shareholders (check your state requirements), and there is pass through taxation where owners report profits or losses on their personal returns, not the company itself (no double taxation). Double taxation occurs due to corporations being a separate legal entity apart from their shareholders, and ultimately if you’re the only owner of the corporation, well then you’re probably holding 100% of the shares. There are circumstances where the principal owner may not have all of the shares, and there are shareholders involved that don’t necessarily “run the business,” but they will of course be taxed on those company profits. So, corporations pay taxes on their annual earnings, which is what an individual does on their taxes. Also, if the corporation ends up paying dividends to shareholders (you as the owner), well, those payments are viewed as income and end up on the shareholders personal tax liability, which is viewed by some as a very controversial rule as this income was also taxed at the corporate level.
Have you already stopped reading?
The Corporate entity may be the best option if:
If you’re looking to be both a shareholder and an employee in the business. Even though you’re the owner, the corporation will hire you to be an officer (typically the CEO), you’re payed a salary (with deductions just like a “regular employee”), and you may even offer a retirement plan or health benefits. Now, I may be losing you here already if I didn’t already do so above. Stick with me.
You own the company and yes, you (the owner of the company) hires you to perform certain duties and be paid as an employee.
If you’re offering fringe benefits, the corporation can write these off, and they’re not taxable income to the employee (you). An LLC will only be able to deduct a portion of the medical insurance premiums, and various other fringe benefits that are provided to its members (owners of an LLC) do not typically have a favorable tax advantage here.
Here’s another example. Let’s also say that you have investors in your business to raise capital. You may be thinking, “no way, I’m not going to be that big from the start,” but actually this could occur at anytime in your business. LLC’s can have a few investors before it starts to get complicated, but essentially an investor can be offered stock in a corporation in exchange for money. LLC’s do not have stock, but can offer “membership units.” Again, this may seem more complicated than you’re really requiring as you start out.
Let’s confuse you a little more:
A corporation may elect to be taxed under a subchapter S (S-corp), and rather than botching the whole explanation, I’ll let Wikipedia give you a more detailed, but potentially more confusing explanation. LLC’s can elect to be taxed as an S-corp. Self-employment taxes may be more favorable in an S-corporation. These taxes are withheld from an employee’s paycheck. Since it’s around the corner, let’s look at the 2012 values. An employer must withhold 7.65% of the first $110,100 of an employee’s pay for Social Security and Medicare taxes. So, the corporation sends the combined 15.3% to the IRS (both the employer and employee portion).
Rather than really making it more confusing, let me allow you to at least read an excerpt from Stephen L. Nelson, CPA, MBA:
“A single-member LLC treated as a disregarded entity reports its income and deductions on a Schedule C tax form if the LLC operates an active trade or business. This tax accounting means that the LLC owner pays self-employment taxes (roughly 15% on the first $100,000 of profits and roughly 3% therefore) on all of the LLC’s profits.
In comparison, a single-member LLC operating an active trade or business and treated as an S corporation has to file a corporate tax return and regular payroll tax returns. However, the S corporation status means that the business pays Social Security and Medicare taxes equivalent to self-employment taxes (again roughly 15% on the first $100,000 of profits and then 3% on profits after that) only on the amount of profit called “wages”.
To show you how powerful this self-employment tax saving gambit can be, suppose that an LLC makes $100,000 in profits. If the LLC is treated as a sole proprietorship, the self-employment tax bill roughly costs $15,000 each year.
If the LLC is treated as an S corporation and the owner, wage amount is set to $50,000, the self-employment tax bill roughly costs $7,500 each year.
S corporation status in this example saves the owner roughly $7,500 annually in employment taxes.”
Okay, so if you didn’t get a stroke, or at the least a migraine from reading this…great! Prepare yourself though, this is only a basic explanation. Advice? Do your research, and don’t hesitate to reach out to your small business association for assistance. Don’t be afraid to get help with this. Oh, and if you’re curious, I chose to form a Corporation (s-corp).