January 20, 2015 by Aaron Scott Young
Hi, this is Aaron Young, CEO of Laughlin Associates and bestselling author of the book, The Corporation Manual. One of the main questions I get while out on the road speaking goes something like this, “I know I want to start a business, I know I want to get incorporated, but which option is right for me?”
All Corporations start out as a C-Corporation. When a Corporation is filed at the state level it is a C-Corporation. If you want an S-Corporation then you file a form 2553 with the IRS.
C-Corporations are what you usually see with publicly traded companies. C-Corporations can be owned by other entities (Corporations, S-Corporations, LLCs or even trusts.)
C-Corporations can have their own fiscal year end. In other words, they can choose their birthday. Other structures go from a calendar year, January through December. But a C-Corporation can decide when it wants to have a fiscal year.
This can be very useful when you have multiple Corporations or entities that are moving money between themselves, making loans, doing projects with each other. It’s useful to have different tax year ends. So that could be useful for you with a C- Corporation.
There’s a ton of interesting things you can do with a C-Corporation. The main thing is, if you’re looking at going public, or you’re looking at being acquired by a public company, or you’re seeking some other reason for going after outside investment capital, a C-Corporation is very likely the right entity for you.
S-Corporations are designated when a form 2553 is filed with the IRS. S-corporations are very popular with small closely held companies – businesses with less than 10 shareholders.
A lot of times those owners are going to be spouses, or relatives, or good, good friends, who want to kind of lock arms and work together to build this company.
They’re on a calendar year. The great thing is, any gains or losses that come from that Corporation are just going to flow up to shareholders’ Schedule C and be filed with the regular tax return. So there’s only one tax return to complete.
S-Corporations are limited in the number of shareholders to 100 and in who can own the shares. First of all, only a human being can own the shares of an S-Corporation, and that human being has to be a U.S. citizen. So if you have an aunt and uncle up in Canada or over in France who want to invest money in your business, they’re not going to be able to do that.
Now the entity you’ve all been waiting for….the mighty Limited Liability Company, also known as the LLC. The LLC is currently the most popular entity formed in the United States at this time.
If you and some friends are coming together to start a new business, and maybe one person as some investment capital, another person as a database, somebody has some technology or other intellectual property they’ve created, and then maybe somebody else is just going to put in the hard work of going out and selling the products and services, and you all come together…
In an LLC, you can decide who’s going to own how much. How are we going to divide up the gains and losses? How is that stuff going to flow out? How are we going to do distributions to different people? You have complete flexibility in an LLC to work with a small, highly-engaged group of members, of owners.
Also, an LLC was designed so you never end up with some partner, some new owner, that you don’t want. With most LLCs, unless they write something different in their operating agreement, if a member dies or leaves, the LLC is disbanded if the other members don’t have somebody they want to bring in in that other member’s place. So what ends up happening is, you have tremendous protection of your dream, of your vision, and of your team.
The other thing that’s really cool about limited liability companies is they have something called charging order protection. And without going into too much detail, what that means is, if there is a lawsuit, and if a member of the LLC loses that lawsuit, then the winner of the case – also known as the “judgment creditor” – can’t come and take away the membership from that member of the LLC. They are only entitled to any distributions from the LLC.
However, the LLC can make the choice if it wants to make a distribution or not. And even if there is no cash distribution made, there’s still going to be a K1– kind of like a 1099– that’s issued to the members. So, what that means is, that the judgment creditor could, theoretically, end up with the tax bill for money that they never received.
Do you understand the implications of that? That makes LLCs a very undesirable target for lawsuits. It makes members of LLCs undesirable for frivolous lawsuits, because the person who might win that lawsuit may never get what they’re seeking, and may end up having to pay taxes, because they threw themselves into the middle of a hornet’s nest.
The big thing for you to remember, when you’re making a choice about what business structures is right– whether it’s a C-Corporation, or an S-corporation, or a Limited Liability Company– is, how is this thing going to protect me?
So when you look at the different entities, you have to say, for my particular situation, with this particular ownership, with these business goals, with this exit in mind, what entity’s going to be the right thing for me?
You want to be looking at what’s right for you, and how is it going to stop problems before they start, and how is it going to give you the most direct path, the smoothest route, to get to the end game that you’re hoping for. Now, some of this can be confusing. And we don’t expect you to have all the answers right away.
How Will This Entity Protect Me?
Will It Give Me Any Tax Benefits?
Will This Entity Provide The Best Foundation For My Business?
As a matter of fact, one of the worst things you can do is make a rash decision about which business entity’s going to be right for you. A lot of times you’re going to have well-meaning friends, family members, or just something you’ve heard– maybe on the radio or you found on Google– that’s going to make you inclined to go a certain way, but that’s not necessarily the right way to do it.
At Laughlin Associates, consulting is always free. You can call and talk to one of our business consultants at 1-800-648-0966. They can answer all your questions. There’s no requirement to buy anything.
Our goal is that when you’re ready to make the leap, when the time is right for you, we’ll have earned your business.
Check out our free whitepaper, Making The Right Choice to learn more on how we can help you take the right steps.