C Corporation vs S Corporation vs LLC
themoneyalert.com
themoneyalert.com
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.
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.
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.
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%.
--> 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.
That forced us into an LLC (and since, into a C-corp).
I'd suggest you talk to a lawyer. 90% of them will be able to cut you a deal on a simple C-corp.
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.
Say I sell my house to fund my business, then my LLC flops and I have to declare bankruptcy. I still lost my house, no?
Now say I take a loan out for $70K to fund my LLC and it flops and I have to declare bankruptcy. Then do I get to keep my house?
What's the difference?
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?
Why would anyone ever choose situation 1?
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!
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"?
I think I need to hit the books...
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).
I happen to have read this last night :)
From S to C? Very easy.