The advantage to going as far as an LLC is that LLCs can be invoiced and can cut PO's. It's also the bare minimum you need if you have cofounders.
Buried in this table is the major difference between LLC, S, and C:
* Any team member who has equity in an LLC is a member, a.k.a. partner, and members can't take W2 wages, only distributions.
* Conversely, employees of LLCs can't technically hold equity.
* Any external investor in an LLC (probably) must be an SEC "accredited investor", meaning that they have $1MM in the bank or several years of income over $200k.
* The major difference between S and C seems to be that C corps can have preferred (ie, VC) stock.
The long and the short of it is that equity is a mess until you're a C corp, and then everything else becomes a mess.
We just went through this decision process. Ended up doing S-Corp for the following reasons:
LLC vs S-Corp:
1. Membership interest vs. Stock: Shares of stock are easier to deal with than membership interests, from an investor and giving to employee perspective.
2. Taxes: Every dollar you take out of LLC is salary (and subject to payroll taxes). In an S-Corp, any money you take out of the business after paying yourself a "normal" salary is a distribution and free of payroll tax.
3. The costs to set-up are nearly the same if you're able to create the articles of incorporation, corporate by-laws, and initial meeting minutes yourself (required for S-Corp). Not that difficult with Google and a $17 book from Barnes & Noble.
4. Conversion to C-Corp if we raised VC money: Much easier to convert from S-Corp.
C-Corp vs. S-Corp:
1. Losses: We expect to incur losses in year 1. In a C-Corp, those can be carried forward to subsequent years in which you have a gain, but in an S-Corp, you can take them on your personal return in that year.
2. Double-taxation: If you only plan to pay a salary, then there is no double taxation, because that's deductible from the C-Corp, however, if you take a distribution, that would be taxed at both the corporate and personal level with the C-Corp (only at the personal level in S-Corp).
3. Investors: Will have to convert to C if we raised VC money, but that's not the plan in the near term, and its easy to switch if we need to.
4. A potential downside to the S-Corp for taxes is that the profits will be taxed at your marginal tax rate (because its all incremental income) as opposed to going through the levels of the progressive tax structure as it would in a C corp. If you only plan to pay yourself a normal salary, then C could be the way to go depending on how much you expect to make.
"2. Taxes: Every dollar you take out of LLC is salary (and subject to payroll taxes). In an S-Corp, any money you take out of the business after paying yourself a "normal" salary is a distribution and free of payroll tax."
--> That one is HUGE in favor of S-Corp over LLC. That's 7% on all income over whatever you can justify as your base salary. If a company is going to be small-ish and profitable for a while, S-Corp is worth a few thousand dollars each year at the cost of added paperwork. LLC has more flexibility, but S-Corp can do all the same things if you don't mind filling out more documents and maybe thinking about it a bit more.
No games. If your normal salary is $100,000 and you want to distribute $1,000,000, that's where this comes into play. And the limit is only on a portion of the FICA taxes (it's actually $100k).
More clearly, the business pays social security tax of 6.2% of each of its employees' salaries up to $100k and medicare tax of 1.45% of each of its employees' salaries with no limit. So, if you take $1,000,000 from the business in a year and $100,000 is your normal salary, Then the business would pay $20,700 in FICA tax under an LLC and $7,650 under an S-Corp.
Conceded. If you're taking a 100k W2 and disbursing $1MM, the S Corp avoids the uncapped 1.4% Medicare tax. If you're taking a $1MM distro, you've got an accountant, and I'm not worried about you getting audited.
If you're most people and you try to split your salary $50k/$50k to avoid FICA on the distro half, I am worried about you getting audited --- not worth it.
Also, lest anyone be overly optimistic, the numbers timae is giving are the business' half of FICA; each shareholder makes up the other half. FICA isn't ~7%, it's ~15%.
Has anyone switched from a C to S corp (yes, you read that right)? How painful was it?
Here is the situation: an existing small, moderately profitable company has decided to stay out of VC circuit, stay private, run it as a life-style business. C corp involves double taxation, which S corp avoids. They had grander dreams once (hence C corp) but now the situation has changed.
If your LLC flops (or your C corp or Sub-S corp) you don't have to declare bankruptcy provided you haven't pledged your personal assets to the company or it's creditors. Your LLC/C/Sub-S creditors can't come after your house or other assets unless you have personally pledged them at some point.
I'm still missing something. Clarified hypothetical situation:
Situation 1: I have a house worth $250K. I sell it and use $100K to fund my business. My business flops; I'm out the $100K.
Situation 2: I keep my $250K house and get a loan from my bank for $100K. My business flops; creditors can't come after my house because I'm behind the LLC firewall, right?
In Situation 2 you have pledged your house against the 100K loan, the fact that an LLC is involved is immaterial. There is nothing that can protect you when you want to take equity out of your house and you lose all of the money.
Situation 3, you borrow money to start your business, it takes off, you pay it back and your business continues to grow. Later you are sued and lose a 10M lawsuit wiping out all of the assets in your business and then some. If you have a corporation your personal assets are normally protected from this loss. Alternatively your large and growing business is struck by a meteorite (which can come in many forms) that wipes out all of your assets but leaves you with the liabilities. If you are incorporated winding down the business normally doesn't affect your personal assets.
(I know you're not a lawyer, but am trying to get an impression for this). Say instead of $10M I get sued for $50K. In the $10M case I clearly can't pay that but in the $50K case, I might be able to sell my car, move into a cheaper house, etc, in order to pay it. Am I protected in both cases? What about $10K? At what point is it "OK, you can't pay this, go declare bankruptcy so you get to keep your personal assets"?
If you lose a lawsuit (or are hit by some flavor of meteor) the business has to pay for it to be able to continue. All that creating a corporation does is to clearly separate what are personal assets from corporate assets.
It may be easier to visualize if you imagine there are several shareholders. Each would want it clear what were the company's assets and what were their personal assets (in addition to their share of the company).
Look at it this way, you buy 100 shares of GM which subsequently goes bankrupt. Your shares may be worthless but GM's creditors cannot come after you as a shareholder for more than the equity that you contributed (the money you paid for your now worthless shares).
Perhaps- but if in situation 2, you pledged your house as collateral, the creditor can still come after it. Generally, if your business is new and unproven, the bank will require you to sign a personal guarantee- or even to put up your house as collateral. Which means that they can still come after it!
If your business gets the loan, with no collateral, and no personal guarantee, then if the business goes bankrupt, the creditors can't come after personal assets! If you are lucky enough to find a bank willing to lend you 100,000 with no collateral, then go for it!
"Contrary to what you may have read just a few years ago, you can now form an LLC with just one person in any state (or the District of Columbia)" - Pg 16, Nolo's Quick LLC
overall it's a useful chart... I just didn't like the liability part for LLCs. To me (a lawyer could prove me wrong - I'm not a lawyer), LLC (and I think S corp) members have the same liability as a proprietorship if they are company operators (ie not just a passive investor).
Buried in this table is the major difference between LLC, S, and C:
* Any team member who has equity in an LLC is a member, a.k.a. partner, and members can't take W2 wages, only distributions.
* Conversely, employees of LLCs can't technically hold equity.
* Any external investor in an LLC (probably) must be an SEC "accredited investor", meaning that they have $1MM in the bank or several years of income over $200k.
* The major difference between S and C seems to be that C corps can have preferred (ie, VC) stock.
The long and the short of it is that equity is a mess until you're a C corp, and then everything else becomes a mess.