May 8/15, 2017: Volume 31, Issue 24
By Roman Basi
(First of two parts)
In the past, choosing a business entity under which to operate was easy. Either businesses operated as a sole proprietorship, a partnership or they incorporated as an “S” corporation or a “C” corporation. There were clear advantages and disadvantages to each one. The sole proprietorship and partnership had the advantage of simplicity and lack of formal arrangements. The C corporation was for national companies, and the S corporation was for those individuals needing asset protection and a formal entity in which to operate.
Today the business structure is not a default arrangement. Businesspeople have an alphabet soup of business types from which to choose. Though many of the new forms offer limited liability and single layer taxation, the tax and legal differences are not nearly as clear as they used to be. This series will discuss three types of business entities and point out some subtle and not widely known differences between the chosen entities.
All three entities are excellent for any small businessperson to operate a company. When deciding which entity to operate under, the owner must take into consideration legal liability, tax circumstances while operating and dissolution, the person’s goals and the size of the operation among other factors. Tax circumstances are of utmost importance when choosing an entity. However, ease of transferability, legal protection and other factors are affected under each entity type.
Limited liability Co. With an LLC, there are no restrictions on ownership. An S corporation, on the other hand, has restrictions. To hold an S corporation status, one must be a resident and citizen of this country. Also, no more than 100 people are allowed to own stock. If the requirements are violated, the company losses its S corporation status and it can’t attain that status for years.
With an LLC, these restrictions do not exist and its status is not jeopardized. While most LLCs will maintain membership of well under 100 members, the option or ability to expand the number of investors rapidly does exist. Many immigrants just starting business can benefit from this classification as well without suffering from double taxation.
While there are formalities with the LLC, failure to follow usual formalities is not grounds for imposing personal liability. This is a major convenience and aids in limiting liability. The other types of businesses identified here are all subject to being disregarded as an entity if the owner does not obey formalities. This is what is known as “veil piercing,” which happens when company owners don’t observe formalities in paperwork, meetings and otherwise use the business as an “alter ego.”
While the owner of the business cannot use the company to defraud people out of money, the LLC liability protection does not require the formality by which corporations must abide. Hence the LLC can be a better insulator against liability if maintenance of meetings and documents is going to be an issue.
Shares of an LLC are easier to put into a trust than an S corporation. To put shares of an S corporation into a trust, special trusts must be used. It can be somewhat complicated and LLCs tend to work very well instead of S corporations if you want to transfer ownership through a trust.
With an LLC, no unemployment taxes are due on income—unlike both the C corporation and S corporation. While this is not a huge tax savings it is significant. If your business is going to make less than $10,000 per year, LLCs might be the way to go. If you’re an at home business, this is particularly important.
Part two will cover the pros and cons of the other entities.
Roman Basi is an attorney and CPA with Basi, Basi & Associates at the Center for Financial, Legal & Tax Planning. He writes frequently on issues facing small business owners.