by Kemp Coady
The company structure you choose can have widespread ramifications for your company and your own personal finances. It may protect you from liability and allow you to legally raise capital. Each type of structure involves special documentation, is subject to certain tax regulations, and requires you to invest some funds for setup and maintenance.
While certain online services provide an easy and inexpensive way to set up a corporate entity, InnovatorsLINK strongly advises that you consult with competent legal and financial counselors. These professionals can help you find which structure makes the most sense for your own business.
LLC, S Corporation, C Corporation, and sole proprietorship are the most common ways to structure a company. This summary offers some details on each type as well as their advantages and disadvantages.
Sole Proprietorship
A sole proprietorship is a company or enterprise that is owned and managed by one person, though it can employ other people. The owner may need to legally trademark their business name. A partnership has a similar framework, with two or more people owning the company together.
Advantages
A sole proprietorship is easy to set up. There’s no need to file separate paperwork to establish this structure. Personal and company tax returns are one and the same.
Disadvantages
Unlike a corporation or LLC, the owner has full, unlimited responsibility for all debts, losses, and liabilities. This can be particularly dangerous if the sole proprietor is sued for an unexpected event, such as an accident involving a company vehicle.
Limited Liability Company
A Limited Liability Company (LLC) is a U.S. business structure that can combine the pass-through taxation of a partnership or sole proprietorship with the limited liability protections of a corporation. An LLC can adopt a tax structure that passes through the profits to the owners’ personal taxes, or it may elect to use corporate tax rules. In order to raise money, an LLC can bring on investors.
Advantages
LLCs are a good intermediary option between a sole proprietorship and a corporation. An owner can be more flexible in establishing a structure that fits their needs, while also avoiding some of the formalities of a corporation such as having a board of directors. Pass-through taxation allows all owners to report the business’s profits and losses on their personal income tax returns. As the name suggests, owners are not personally liable for any business debts or legal damages.
Disadvantages
An LLC is more expensive to form than a sole proprietorship, and may be subject to additional self-employment taxes. The advantages of an LLC may prove to be disadvantages for some companies. For example, shareholders may not appreciate pass-through taxation since profits and losses are reported whether or not they receive dividends, meaning an LLC might be better suited for companies with fewer owners. It can also be harder to attract investors to an LLC, and the relaxed structure may lead to problems in governing the business unless a detailed operating agreement is created.
The S Corporation
An S Corporation offers liability protection for an individual’s personal assets resulting from corporate operations. The corporation’s income and losses are divided among the owners and shareholders, who must report the income or loss on their personal income tax returns. To structure your company as an S Corporation, you must file IRS Form 2553 (shown below) for federal tax purposes; you may also have to file additional paperwork for state tax purposes.
Advantages
The S Corporation is set up such that the income passed through to the owners (shareholders) is only taxed once at their personal tax rates. Income paid out to owners in a C Corporation is taxed at the personal level and any dividends paid out are first subject to corporate and then personal tax rates.
Disadvantages
The S Corporation is subject to strict qualification restrictions under federal tax law, and is also more rigid in its profit and loss allocations and its formal requirements. It is not structured to raise equity capital from venture capitalists and others.
C Corporation
The C Corporation is the type of business structure where you file articles of incorporation with your secretary of state to register your business as a corporation. The corporation is taxed separately from its owners, paying taxes on earnings before dividends are distributed to shareholders.
Advantages
Like the S Corporation and LLC, the C Corporation offers liability protection from the debts and obligations of the company. It can issue equity shares to raise money for expansion. The company can also have many shareholders.
Disadvantages
Income left in the C Corporation will be taxed at what may be lower taxation rates. But dividends are subject to double taxation of both corporate and personal taxes. The owners can borrow money from the C Corporation, but we advise you to consult with your accountant if you plan to access money this way.
2017 Tax Benefits for Sole Proprietorships, LLCs, and S Corporations
The 2017 Tax Cuts and Jobs Act was all about lower tax rates for businesses, specifically the cut of the graduated tax rate on C Corporations from a high of 35% to a flat 21%, along with a 20% deduction available to qualified pass-through businesses, including S Corporations, LLCs, partnerships, and sole proprietorships.
If you’d like more help with finding the right solution for housing your startup, InnovatorsLINK offers a detailed Bootcamp course where you’ll learn the details about all your options. Register here.
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InnovatorsLINK, Inc. General Manager and Chief Financial Officer
A SENIOR LEVEL EXECUTIVE with over 30 years successful, results-oriented domestic and international experience in the MEDICAL DEVICE BUSINESS. A Business Leader who created significant increases in profits and cash flow and/or raised money to expand enterprises. A Leader, who attracts and motivates the best talent to achieve the desired results. Board member for AMEX, NASDAQ, and London Stock Exchange companies. Significant international experience in Europe, Latin America, and Japan. Experience the last seven years has included Professorships at Goldman Sachs 10KSB program and University of Connecticut Graduate School of Business. Earned BS Bates College, MBA and MPS Cornell University.
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