When selecting a legal business entity structure for their startup, many founders choose poorly. Many believe that they must have Inc. after their name to be a “real” company, creatingadditional, unnecessary complexities and costs. Government Contracting Academy founder, Randy Wimmer, is confident that filing as an LLC will meet the initial needs of the vast majority of startup founders to get their company up and running. Besides, you can always convert your LLC to an Inc. Conversion in the opposite direction, from an Inc to an LLC, is not as simple and may not even be possible in some states.
After selecting a company’s name, determining whether you want your startup to be a Limited Liability Company (LLC) or a Corporation (Inc) is your next major decision. Once you make that decision, then you must decide how you want to be taxed. For an LLC you may be taxed as either a Sole Proprietor, Partnership, or a Corporation. If you go the Inc route, then you must determine if you want to be taxed under a C or S Designation.
Although this sounds confusing, it really isn’t…unless you have an attorney explain it to you. Deciding between an LLC or a Corporation depends upon where you wish to physically operate, your need for external investors and your taxing preferences. Both structures establish a separate legal entity that may operate in the United States while protecting your family’s assets. However, that is where the similarities end.
An LLC provides for a very streamlined filing of Articles of Organization and offers tremendous flexibility regarding its management structure and tax reporting. The downside of an LLC is that it is not ideally organized to easily support a large number of external investors who wish to purchase ownership shares. An LLC may also be limited to operating within the United States since LLCs may not be recognized by some foreign companies or governments.
An Inc is a more complex entity that is structured to allow “shares” of the company to be administered. This structure easily enables outside investors to own a stake in your company should you need cash. An Inc is also the best structure when you realize your dream to “go public.” Plus, it may operate outside of the United States.
Once you select your legal entity structure then you must decide how you want to be taxed. As an LLC, you may elect to be taxed as a corporation or have your company profits pass-through as personal income, as either a Sole Proprietor or a Partnership. As an Inc, you might have similar options. If you meet specific requirements, then you may file under the S Corp Designation and have your profits be taxed as individual income as a “pass through.” Otherwise, you must be taxed under the C Corp Designation as a corporation.
So, what do these tax filing options mean in layman terms? Randy simplifies these options by explain the real value of an LLC is that owners are guaranteed to only pay taxes on company profits once. As the owner of an LLC, you may file a Schedule C as part of your personal income tax filing. A Schedule C shows your LLC’s revenue, costs, and profits. Your taxable profits are then included as part of your overall taxable income.
If you’re taxed as a corporation, then your company must pay taxes on its profits. And after it pays its taxes, then it pays you distributions from what is remaining. And gulp! You are then taxed on your distributions! Many people consider this being “double taxed.”
Of course, there are clever ways that your tax attorney or CPA may mitigate this “double taxing,” but most people don’t want to go down that road unless they absolutely must be a Corporation. As an aside, if your corporation meets certain requirements, then you may be allowed to file taxes as an S Corp, which is virtually the same as an LLC. Again, unless you must establish your company as a S Corp, then why go through the hassle when you can register your LLC online for $100 or less in most states and be a Limited Liability Company in a matter of minutes! And remember, you can always convert an LLC to an Inc, but the opposite is not always true!