When you started out as a business owner, you probably registered your company as a sole proprietorship. This type of legal identity is straightforward and provides a young enterprise and its owner with immediate advantages. For example, there are few formalities or paperwork; your business losses can be deducted from your personal tax return; and tax filing, in general, is relatively uncomplicated. As your company has evolved, however, you may have realized that you can only expand so much as a sole proprietor. You may have reached a conclusion that in order for your business to grow more, protect yourself, and have certain tax advantages, you need your business to become a separate entity.
Once you’ve made the choice to move forward with your business, you need to decide what legal entity you want your company to transform into. If you want to organize your business as a corporation, you have to choose between a C-corporation and S-corporation. You also have the option of registering as a limited liability company (LLC) or limited partnership (LP).
Which one will be the best for your business? This decision depends on many factors and is only yours to make. In this article, we offer a description of each of the business entities along with the advantages they may provide to your business.
Limited Liability Company
Even though a limited liability company (LLC) is not, strictly speaking, a corporation, it does exhibit some features of it while still allowing the owner to be at the helm of the decision-making process. A limited liability company must file a certificate of formation with the Texas Secretary of State. An LLC is owned by its members.
LLCs offer great flexibility with regards to organizing a business. For example, if you and your partners still want to make all the crucial decisions affecting your business, an LLC can be organized to be managed by members only. However, the members may also choose managers who will run the company on their behalf. In any case, the key advantage of an LLC is that owners will not be personally liable for the business’s debts or liabilities. Other important advantages of organizing the business as an LLC is that members can choose how they want the company to be taxed (as a partnership or as a corporation), how they want the company distributions to be shared, and there are fewer formalities or rigid requirements as compared to a corporation.
S-Corporation
The S-corporation designation provides a complete legal separation between the business and its owner(s). Thus, the owners have no personal liability for the corporation’s debt or legal liabilities. A corporation can sue and be sued, pay taxes, and hold property – all independently and separately from its owners.
Owners of an S-corporation are called shareholders. Shareholders do not take an active part in the daily activities of the company or decisions made regarding its operations. Shareholders’ approval is needed only with regards to the most fundamental actions.
Most of the decisions regarding the corporation’s operations are made by the board of directors. The members of the board are elected by the shareholders at the annual meeting. The directors, in turn, appoint key managerial staff called executive officers. These include a president, vice-president, treasurer, and secretary. It is possible, however, for an S-corporation to be operated by a sole shareholder who will fulfill all or most of the roles mentioned above.
One of the biggest advantages of registering a business as an S-corporation – apart from the liability protection for the owners – is pass-through taxation. This means that it is not subject to a separate federal income tax. Any business loss or profit is “passed through” to the shareholders who are required to report it on their personal tax return.
C-Corporation
C-corporations share many organizational features with S-corporations. They too operate as separate legal entities, providing limited liability benefits to the shareholders. Similarly, they are managed by a board of directors and executive officers but again, one person can fulfill all these roles.
A crucial difference between a C-corporation and an S-corporation lies in taxation. A C-corporation is taxed separately from their shareholders. It is required to file a corporate tax return and pay taxes at the corporate level. In addition, if income made by the corporation is distributed to the shareholders in the form of dividends, there is a possibility of double taxation. First, the corporation pays a corporate tax. Then, shareholders pay income tax on their dividends.
Another difference is that C-corporations have no restrictions on ownership, which means there may be an unlimited number of shareholders (S-corporations can only have up to 100 shareholders and they must be US citizens/residents). In addition, C-corporations are allowed to issue different types of shares, creating a hierarchy of shareholders with different voting rights. By contrast, S-corporations can issue only one class of stock so all shareholders have equal voting rights.
Registering Your Company as an Entity? Call a Lawyer
As you can see, all of the legal and economic issues related to setting up and operating an incorporated business are complex and require much more explanation. That’s why if you are planning to register your business as a corporation, it would be wise to consult an attorney educated in Texas business law and experienced at advising business owners. Fraser, Wilson & Bryan, P.C. will be happy to provide counsel for your Texas business. Call us at (254) 965-7270 to schedule a free consultation or contact us via our website at https://fwblawtx.com/contact-us/.
