Which Business Entity is Right for You?
August 2015 - By Michele Diglio-Benkiran
One of the most important decisions you will make when starting a new business is deciding what type of business entity your business will be. In order to avoid unlimited personal liability business owners can form a C-Corporation, an S-Corporation or an LLC and shield their personal assets. While these entities share many of the same characteristics, it is important to know their unique qualities in order to choose the one that best fits your needs. Here are a few things you should know before making this important decision.
Business Entity and Liability
C-Corporations, S-Corporations and LLC’s are similar with respect to how their shareholders or members are not personally liable for the debts or activities of the business. This means that, should the business fail, creditors may only go after the assets owned by the business. This concept of limited liability is the cornerstone for choosing one of these three entities over a partnership or sole-proprietorship.
However, the limited liability provided by a corporation or LLC is not absolute. Recent developments in jurisprudence have permitted judges to “pierce the veil” of corporations and LLCs to hold owners personally liable when the business has engaged in malicious or fraudulent activity. In such cases, a shareholder’s personal assets will not be shielded from liability when there is total control by the shareholder(s) over the business activities, the use of such control to commit fraud or wrongdoing, and such control and wrongdoing causes harm.
Both C-Corporations and LLC’s have no restrictions on who or how many owners the entity may have, but S-Corporations are much more limited. An S-Corporation may have up to 75 members, referred to as “shareholders,” and each must be a United States citizen or resident. Non-resident aliens cannot be shareholders of S-Corporations. Additionally, S-Corporations may not be owned by other S-Corporations, C-Corporations, LLC’s, partnerships, and many forms of trusts.
Other differences in ownership exist concerning the type of property owned in the business. Corporate shareholders own stock in the corporation that can be freely transferred to others while members of an LLC own an interest that may be subject to limitations on its transfer by the LLC’s operating agreement. For both C-Corporations and LLC’s, separate interests in the businesses may be treated differently while stock in a S-Corporation may vary in how it confers voting rights in the corporation.
Taxes and Business Entities
One of the most important and distinguishing characteristics of these business entities is how they are taxed. C-Corporations differ from both S-Corporations and LLC’s with respect to how its members may be “double-taxed”. Because C-Corporations are separate taxable entities they must file a Form 1120 and pay Corporate Tax Returns. Subsequently, the personal income corporate shareholders derive from their ownership of a C-Corporation is then also taxed. This taxation at both the corporate and individual level is referred to as “double taxation.”
In contrast S-Corporations and LLC’s are “pass through” entities. This designation refers to how S-Corporations and LLC’s do not file separate Corporate Tax Returns. Instead, taxes “pass though” the entity and the owners are responsible to report and pay their applicable taxes at the individual level.
Generally an LLC is taxed at the same rate as a partnership or sole proprietorship unless it elects to be taxed as a corporation. A C-Corporation or S-Corporation will always be taxed as a corporation, but unlike an LLC, owners of a corporation are usually not subject to self-employment taxation or passive activity loss restrictions. An S-Corporation may lose its status as S-Corporation and default to the status of C-Corporation.
Structure of Business Entities
A business owner who creates a C-Corporation or S-Corporation must adhere to the strict formalities that govern the structure of corporations. The corporate structure consists of shareholders who own the company; officers who conduct the day-to-day activities and directors, who are elected by the shareholders and control the major affairs of the corporation. The directors of a corporation also owe a fiduciary duty to the corporation and its shareholders. Both C-Corporations and S-Corporations are also required by law to follow certain procedural guidelines like filing annual reports and voting on bylaws.
LLCs allow for more flexibility in their structure. They may either be member-managed or manager-managed. A member-managed LLC allows for any member of the business to make binding decisions on behalf of the entire entity. A manager-managed LLC may be managed by a member or group of members who are given the power to make binding decisions for the business. An LLC’s Operating Agreement, which governs many of the variable rules of how an LLC conducts business, may be an informal, oral agreement.
Business Entities: Formation, Duration, and Termination
C-Corporations, S-Corporations, and LLCs may be created by filing Articles of Organization with the appropriate government agency. When any corporation is created it is presumed to be a C-Corporation unless an S-Corporation election form is subsequently filed with the IRS.
Both C-Corporations and S-Corporations exist perpetually while LLC’s may be dissolved by the departure of a member, the occurrence of a condition, or lapse of a period of time. All three entities may be dissolved by order of a judge or upon filing Articles of Dissolution with the appropriate government agency.
Which Business Entity is right for me?
While it may be tempting to categorize certain business entities as better for particular types of businesses, the truth is that it all depends on your individual goals and expectations for the business. For an LLC, its advantages lie in its flexibility, limitless number of owners, lower tax rate, and ability to own other business entities. On the other hand, members’ interests may be subject to transfer restrictions, it may still be taxed as a corporation, and there is a limited amount of case law available to provide guidance for unsettled areas of LLC law.
Choosing to form a corporation provides business owners with well-established case law governing their organization, a familiar corporate structure, and easily transferable interests that can promote investment and growth. The decision between creating a C-Corporation or an S-Corporation should consider the potential for growth, as moving from a C-Corporation to an S-Corporation might be somewhat of a difficult task.
In order to make the decision that is best for your business and its future you should consult an Orlando business formation attorney, experienced in matters of business law. At NeJame Law, our business law attorneys are both experienced and qualified to answer any of your business law questions. Please call (407) 500-0000, fill out our online form, or email us at attorney@NeJameLaw.com and we will contact you shortly. As always, we value your privacy and will keep any information strictly confidential.