Personal Injury comes with a lot of questions. While we can’t answer all of them on a single webpage, this article does address some of the biggest question marks that might be hovering over your own decision about what direction you go (and how to do so).
Remember: every situation is different. Because of the uniqueness of your circumstances there is really no substitute for directly speaking with an experienced lawyer.
What Is An S-Corp?
The first thing to know is that an S corporation (commonly called an “S-Corp”) is an IRS tax classification— not a type of business entity.
An S corporation is a corporation that’s treated as a 'pass-through entity' for federal tax purposes. The “S” in 'S-Corp' refers to Subchapter S in Chapter 1 of the Internal Revenue Service’s tax code.
How S Corps are Taxed
If a business is a pass-through entity, that means its profits, losses, deductions, and credits are passed along to its owners, known as "shareholders." The owners report this information (and pay the associated taxes) on their personal income tax returns.
S corp tax status is an attractive choice because it offers liability protection and tax savings while making it easier to transfer business interests.
This federal status allows S corporation shareholders to avoid double taxation on any corporate income. Double taxation means revenue is taxed on both the corporate and individual income tax levels. This is the norm for shareholders of C corporations, the most common type of corporation.
If a C corp makes a profit and wants to distribute dividends to its shareholders, it first has to pay taxes at the corporate rate, and then shareholders pay taxes at their individual rate. But as an S corp owner, you’re only taxed once, subject to your personal tax rate.
S corp owners also receive limited liability protection. Forming an S corp legally separates the business and its owners. As a result, shareholders aren’t personally responsible for business debts or liabilities.
Lenders or creditors can’t pursue your personal assets, like your house or car, unless you’ve agreed to a personal guarantee when taking on the loan or credit. This fact also distinguishes S corps from sole proprietorships and partnerships, which don’t shield owners from personal liability.
As we mentioned earlier, you can’t actually register your business as an S corporation. Instead, you’ll elect S corporation status for your corporation or limited liability company (LLC) after forming it. But not all small business owners are eligible to elect S corp status.
What Businesses are Eligible for S Corporation Status?
In order to choose S-corp status, you have to meet certain IRS criteria. Your business must:
- Be a domestic corporation. Your business has to be based and operating in the United States.
- Have only allowable shareholders. S corp shareholders can be individuals, certain trusts, and estates. They can’t be partnerships, corporations, or non-resident alien shareholders.
- Have no more than 100 shareholders. The number of shareholders can’t exceed this limit at any point in the company's existence.
- Have only one class of stock. You can’t offer multiple types of stock, like common stock and preferred stock, to employees or investors.
- Be an eligible business type. Certain businesses, including financial institutions, insurance companies, and sales corporations, aren’t allowed to form S corporations.
These guidelines cover federal requirements, but your state or municipality may have additional rules. Check with your state filing office — usually the Secretary of State office — to see if there are other criteria.
What Is a C Corp?
C corporation is an entity type that's owned by shareholders who purchase shares of stock. Unlike an S corp, which is a pass-through entity that is taxed on shareholders' personal returns rather than on a business return, a C corp is prone to double taxation — both the profits of a C corp business and any shareholder gains made on the distribution of dividends can be taxed.
For example, let’s say your corporate profits are taxed at a corporate level. Then, the shareholders receive their cut of the company profits. At this point, the shareholders would then be taxed for their personal income — in this case, the profits from your company — on their personal tax returns.
Because a C corp is technically owned by shareholders, a board of directors needs to act as the decision-makers for the company. The board will also establish bylaws, which dictate how the business operates. This is radically different from a sole proprietorship, in which the person and the company are one and the same.
In the case of a C corp, the shareholders may have little involvement in the company itself. (Or a lot, depending on the company and the shareholders, but this involvement isn't a given like a sole proprietorship.)
In short, C corporations are strictly regulated and have a rigid structure: shareholders and a board of directors. This makes them rather easy for investors to understand, which is a positive. When investors are looking for companies to invest in, they want safe bets. LLC structures can vary, which means they take longer to comprehend and could be less appealing to investors as a result.
As C corps are more heavily regulated, those interested in selling a company or securing investors typically choose a C corp structure. Like an LLC or S corporation, a C corp provides a certain amount of legal protection to business owners and investors, as the owners are treated as separate entities from the business itself.
What Is An LLC?
An LLC, or limited liability company, is a business entity formed through articles of organization. An LLC, much like a C corp, treats the owners of a company and the company itself as separate entities. This means the owners aren't always financially and legally liable for company debts, but legal protection can vary depending on state laws. This limit of personal liability protects personal assets and ensures business owners don't necessarily go down with their company.
Beyond liability protection, an LLC gives companies a way to structure their business as they see fit. Unlike a C corp, an LLC is still owned and operated by those who found the business. A board of directors can be chosen, like in a C corp, or not. There can even be single-member LLCs, which are essentially sole proprietorships with the added protection of an LLC.
Because LLC structures can vary, they aren't the best choices for those seeking investors or angel investors. Their structure requires more research on the investor's part. All C corps, on the other hand, are generally operated the same way: A board of directors makes major decisions based on input from shareholders.
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5 Differences Between C Corp and LLC
1. C corps can reorganize free of charge
Tax reorganizations can be useful for U.S. businesses and U.S. citizens looking to restructure a company for acquisition or investment. But, oftentimes these tax reorganizations can be costly. For C corps, tax-free reorganizations are possible and common, thanks to IRC Section 368. This allows your business to be sold free of taxation in exchange for stocks. For LLCs, this isn’t possible.
Because a tax reorganization is especially useful for businesses looking to avoid expensive tax costs during a business sale, C corps are a strong entity type to consider for anyone forming a business with the intention of selling it.
2. C corps have no cap on stockholders
LLCs don't allow for stockholders because of the way they're structured. A C corp can not only have stockholders, it can have unlimited stockholders. This can potentially make acquiring venture capital or finding startup investors easier for C corps than for LLCs.
The downside is that more stockholders often means more shareholder meetings with the board of directors. When left unchecked, this could lead to a company no longer feeling like your company. Without proper restrictions put in place, it’s even possible for you to lose control of your company. This is why it’s important to ensure you have classes of shares, creating clear boundaries between shareholders and your company.
3. Limited liability companies offer truly shared ownership
Along with limited liability protection, an LLC offers truly shared ownership. While you can choose to operate a single-member LLC, you can also split the company evenly between multiple people, like in a partnership. This means the profits can be shared equally, which is virtually impossible when you run a C corp and have stocks involved.
4. LLCs can have custom management structures
C corps are generally rigid in structure: a board of directors manages the company and makes decisions while shareholders have some say. An LLC can have a much more custom structure. For example, you may have multiple LLC members, each with a different role, or each part of a shared general partnership, splitting the business profits, business debts, and responsibilities.
Again, the downside to an LLC’s custom structure is that investors may be less inclined to invest. Your custom management structure can entail more homework on the investor's part to understand how your company operates and who is in charge of what. In many cases, a C corp is an easier "yes" for an investor because they know exactly what to expect as far as management goes.
5. C corps are recognized around the world
LLCs have an uphill battle when it comes to global operations and legal protections. Both C corp and S corp status are globally recognized, meaning your business can more easily operate around the world with legal protections. For many small business owners, this isn't a deal-breaker. But, if you're looking to grow your business beyond the United States, a C corp may be a better long-term choice.