When you decide to start a business often the first question you face after deciding what business you will be doing is “Which entity should I choose?”. This slows down many entrepreneurs in the start-up process. This is not taught in elementary school, college, business school or even most law schools. Entrepreneurs are often stuck searching the web, reading books.
However, at IncorpTaxAct, this is our lifeblood. We live and breathe this – and enjoy it. We are patient to make sure you can make an informed decision to help your business succeed.
Very commonly asked questions are, “Which entity should I choose,” “What is Inc.,” “What does Co. mean,” “What is LLC,” “What does LLC stand for,” or “Ltd vs. LLC?” Before you incorporate, you need to choose which type of entity is right for you.
Businesses are formed at the state level, and state law differs with regard to these entities. Let’s understand or find out simple answers to the above questions –
“Which entity should I choose,”
There are number are options available and depending on your business requirement and future plans you can decide what entity you want to choose. The available options are –
Sole Proprietorship (or DBA– doing business as) – no liability protection whatsoever, inexpensive to form, but very risky.
GP (General Partnership) – no personal liability protection – partners are each jointly and separately responsible for all of their partners actions,
LP (Limited Partnership) – requires both active managers called general partners and passive investors called limited partners – Weakness: does not protect the general partner from personal liability,
LLP (Limited Liability Partnership) – usually only for professionals like lawyers and doctors – Weakness: does not protect you from your own negligence,
LLLP (Limited Liability Limited Partnership) – same as LP, but it offers general partner personal liability protection – Weakness: unusual form of entity that is similar to an LLC, but unnecessarily complex,
If you choose to incorporate a business, you move from a Sole Proprietorship or General Partnership into a company that’s recognized by a state of incorporation. This makes it a legal business entity that is separate from those who founded it. This new structure falls into one of two categories:
LLC (Limited Liability Company)
INC (Corporation or Incorporation)
Which is better option an Incorporation or an LLC?
There are three types of Business entities most of the Start up companies chose from, that is LLC a limited Liability company and Incorporation is further divided in to a C Corp and an S corp. The critical factor when deciding between an LLC, C Corp and an S Corp is whether you will be seeking an outside investor and whether the entity will start making profit soon.
What Does LLC Mean?
LLC stands for Limited Liability Company. Generally speaking, the best form of entity for most small businesses and property owners is the Limited Liability Company (LLC).
Formation – An LLC is formed by one or more owners, called Members by filing an Articles of Organization.
Ownership – The owners of an LLC are called “members,” and each member owns a designated percentage of the company, sometimes called a “membership interest.” Membership in an LLC may be more difficult to transfer than shares in a corporation. An LLC’s operating agreement will typically specify whether and how membership interests can be transferred. In some states, if a member leaves an LLC and the operating agreement does not specify otherwise, the LLC must be dissolved.
Taxation – LLCs have flexible tax structure. An LLC is taxed as a pass-through entity by default. This means that the profits of the business are “passed through” to the owners (called members). By default, a single-member LLC is taxed like a sole proprietorship and a multi-member LLC is taxed like a partnership. That means that the LLC’s members report and pay tax on business income as part of their personal tax returns. LLC members—unlike corporate shareholders—may also be liable for self-employment taxes.
Management – LLCs are a newer concept, and they are designed to be more flexible in the way they are managed. An LLC can be managed by its members or by a group of managers. Typically, in a member-managed LLC, the owners are heavily involved in running the business, while a manager-managed LLC usually has investors who don’t have an active role.
Liability Protection – Limited liability is a type of protection for your personal assets. It ensures that your personal liability for the business’ debts and obligations is no more than the amount of money you invested in the business. This protects your home, automobiles, and other personal assets from being used to pay off any debts accrued by your business. Without limited liability protection, your home could be used as collateral to repay the businesses debt after a lawsuit or bankruptcy. This is, by far, one of the greatest advantages gained by forming a business entity.
What Does INC. or Corp. Mean?
The abbreviations “INC.” and “Corp.” indicate that a business is a corporation. Both LLCs and corporations are formed by filing forms with the state. Both protect their owners from liability for business obligations. There are two types of corporations, an S corporation and a C corporation. There are many benefits to incorporation, such as being protected from personal liability and having credibility with your customers. There are also specific pros and cons to each incorporation type.
Formation – An INC. or a Corp. is formed by filing an Articles of Incorporation. Articles of incorporation is a set of formal documents filed with a government body to legally document the creation of a corporation. Articles of incorporation must contain pertinent information such as the firm’s name, street address, agent for service of process and the amount and type of stock to be issued.
Ownership – A corporation can issue shares of stock and sell percentages of the business to its owners, which are called shareholders. These shareholders can transfer shares, purchasing more stock to own a larger percentage of the company, or selling off stock to own less. If your business is one that wants to attract outside investors, a corporation may be the best entity for it. A corporation also exists in perpetuity separate from the owners, meaning that a corporation remains in existence even when an owner leaves or divests from the company.
Taxation – Corporations are taxed as a separate legal entity, which can earn its own income. Corporations are responsible for paying tax on their profits, (corporate tax), and tax on dividends the entity distributes to its shareholders. A “C” corporation pays taxes on profits. Shareholders pay personal tax on the dividends they receive. Since dividends are not tax deductible (like salaries and bonuses), dividends are taxed twice. This is referred to as “Double Taxation”.
An S corporation doesn’t pay corporate income tax, but the corporation’s profits pass through to the shareholders’ personal tax returns, and each shareholder pays tax on his or her share of the profits. Corporations that have 100 or fewer shareholders and meet other requirements can avoid double taxation by choosing to be taxed as S corporations.
Management – Corporations have been around for a long time, and they have a fairly standard and rigid management structure. A corporation must have a formal structure with a Board of Directors handling the management responsibilities of generating profits for the shareholders. Corporate officers are assigned to handle the day-to-day operations of the business. In larger corporations, shareholders are less likely to be involved in running the business. The rights and responsibilities of the directors, officers and shareholders are spelled out in the corporation’s bylaws. The shareholders are considered owners of the corporation but remain separate from business decisions and daily operations of the corporation. However, shareholders retain the power to elect directors, and individual shareholders can be elected as a director or appointed as an officer.
Liability Protection – A corporation is an independent legal entity created under state law with a legal existence that’s separate and distinct from its owners. Corporations are the most widely accepted and well-established entities for investors to protect themselves from personal liability for the actions and debts of a business. A stockholder of a corporation will only be held personally liable for the actions and debts of the business up to the amount of such stockholders’ investment, regardless of the stockholders’ involvement in the management of the business.
Please note that the contents of this document may not cover all the required points for your business. This document is subject to change without notice. For questions please contact Pramod Sathe at email@example.com or call us at +1 (770) 682-3119. You can also visit http://www.incorptaxact.com for more information.