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How to Choose the Right Legal Structure for a Business

By Edited Apr 15, 2016 0 0

The Right Legal Structure for Your Business

So you want to create a business, but you are not sure which legal structure is right for your business? You must learn the differences between the three main types of legal structures - the S Corp, C Corp, or LLC. Whatever you do, you need to incorporate to protect yourself and your assets.

Limited Liability Company (Often incorrectly referred to as a Limited Liability Corporation)

According to an Inc.com article "How to Incorporate:

"This structure essentially melds a partnership with the limited liability protection offered by a corporation. The LLC is a recent innovation -- most states didn't recognize it until the mid-1990s -- but because of its flexibility, lawyers have come to recommend it for most small companies. Only a few states put a limit on the number of owners (called members), which can usually include corporations, other LLCs, and foreign entities. Many states allow individuals to form LLCs, too."

The LLC is a  hybrid business entity, having certain characteristics of both a corporation and a partnership or sole proprietorship (depending on how many owners there are), according to Wikipedia. The LLC is often more flexible than a corporation, and it is well-suited for companies with a single owner.

The advantages of starting an LLC is the flexibility, as you can elect to be taxed as a sole proprietor, partnership, S corporation or C corporation.

However, Inc.com says a disadvantage of the LLC is that you can't distinguish between income earned as salary and passive investment income. Therefore, they say that profits are subject to Social Security and Medicare taxes on top of income taxes.

C Corporation

Inc.com says, "This is the basic type of American corporation, but relatively high tax rates make it unpopular among small companies. Because its shares can be freely traded among an unlimited number of owners, the C corp is the most tax-efficient vehicle for taking a company public. It is also the best vehicle for a tax-free merger in a stock swap."

"The corporation files its own tax return and pays tax on its income. When profits are distributed as dividends to shareholders, they are subject to further tax -- a double tax, some argue -- on their individual returns. However, because the corporate tax rates for income below $75,000 are lower than the individual tax rates, some experts recommend a C corp for small growing companies that reinvest their profits. Unlike an LLC, a C corp can distinguish between active and passive income and pay employment taxes only on the salaries of the active shareholders."

 S Corporation

 S corporations do not pay any federal income taxes, instead, the corporation's income or losses are divided among and passed through to its shareholders. The shareholders must then report the income or loss on their own individual income tax returns, according to Wikipedia. However, your business must meet certain criteria: In order to make an election to be treated as an S corporation, the following requirements must be met: You must be an eligible entity (a domestic corporation, or a limited liability company which has elected to be taxed as a corporation), you must have only one class of stock, an you must not have more than 100 shareholders. So as you can see, the S corporation is much less flexible than an LLC because of all the technical requirements.

Always consult with a legal professional before making a decision on which legal structure is right for your business.

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