S Corp Vs LLC - Ownership Structures
By Ye Cheng Yuan
Choosing an ownership structure for your new business is really not as hard as extracting your wisdom tooth on your own. If you file taxes yourself, you are probably well equipped to do this without a lawyer or an accountant. Remember, you can always choose to convert to another form of ownership later.
To begin, let's examine the four types of ownerships you can choose from:
- Sole Proprietorship
When I read about another tort case in the news, it often reminds me of the word "extortion". Granted, not all tort cases are frivolous, there is still room for improvement in tort law. Like everyone else, I work hard to earn a living. In the process, I hope to accumulate some assets in my lifetime. I'd hate to lose everything in a lawsuit. When you run your business as a sole proprietorship, you are risking all your assets. That's a good enough reason for me not to choose the sole proprietorship.
But if you have a partner, which most startups do, sole proprietorship is out of the question. For multiple-owner businesses, a partnership offers the ease of formation much like a sole proprietorship and pass-through taxation (there is no tax at the partnership level). However, partners in a partnership are liable for each others' actions. A limited partnership affords invested capital protection for the limited partners, but the general partner, who manages day-to-day operations of the business, is liable for all actions. If you work for your business, you are a general partner. Hence, a partnership structure still does not offer the limited liability I'm seeking.
- Limited Liability Company (LLC)
This brings us to the next ownership structure: a limited liability company (LLC). An LLC is like a souped-up partnership. It has the pass-through taxation advantages of a partnership plus, as its name implies, limited liability for its members (owners of LLCs are called "members"). The major difference between an LLC and a partnership is that an LLC is legally recognized as a separate entity, hence the limited liability protection advantage. Although I compared an LLC to a partnership, it is possible to form an LLC with just one member to take advantage of the limited liability protection.
There are two types of corporations: a C Corporation and an S Corporation. A C Corp offers the same limited liability protection that LLC offers. Most publicly traded companies are formed as C Corporations because this ownership structure has been around for a long time. The regulations governing C corporations have matured and therefore well understood by many. Despite its popularity, a C corporation has its drawbacks. One that stands out is its double taxation. That is, your corporation is taxed once at the corporation level and a second time when wages are paid to you. Yuck!
Tired of paying so much tax, the rich businessmen came up with the idea of an S Corporation. Someone once said "Tax laws are written by the rich for the poor." Indeed. The S Corporation is, as you might have guessed, a C Corporation with the pass-through tax advantage. Since I hate paying too much taxes as well, I thought a C corporation is not such a good idea.
Deciding Between LLC And S Corp
Since both LLC and S Corporation provide the same liability protection, the decision boils down to several points to consider:
- Tax implications
- Registration and maintenance costs
- Employees and future ownership changes
Before I brush off liability protection altogether, it is important to bear in mind that your personal assets are only protected if you have conducted your business within legal boundaries. If you sell drugs, commit fraud or worse deliver spam to my e-mail, not only your personal assets are on the line, I will personally come after your firstborn.
In my next post, I will discuss the tax implications of choosing an LLC and a corporation. Stay tuned!
I'm Ye, a Principal of Qovax [http://www.qovax.com]. Qovax is a small web development company that builds beautiful websites and thoughtful applications from sunny California. Our product IncBaby [http://www.incbaby.com] helps startup entrepreneurs generate Articles of Incorporations in minutes for free.
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