Choosing the Entity that’s Right for your Startup

July 7, 2015

As a startup business, one of the most important decisions you have to make is under what type of corporate entity you’ll operate.

There are three basic choices of entities.

S Corporations

Characteristics. This entity is only for corporations with 100 or fewer individual owners and no foreign shareholders are permitted. S Corporations can issue common stock, not preferred, and there are no corporate taxes paid at the entity level.
Advantages. S Corporations are simple to set up. There’s no double taxation, meaning that corporate income is taxed on the owner’s personal income tax return and not at the corporate level. Corporate profits can be accessed to pay personal income tax via tax-free distribution.
Best choice when the company is primarily self-financed or financed by friends and family, and owners don’t want to limit or surrender control.
Cautions and limitations. New York City does not recognize S Corporation status so the corporation must pay an 8.85 percent city tax on profits. It is important to note that businesses in New York, New Jersey and a couple other states need to file separate S Corporation elections after submitting Form 2553 with the IRS. Owners should take “reasonable compensation” from a profitable S Corporation.

C Corporation

Characteristics. The C Corporation is a separate tax-paying entity and the shareholders will pay tax again on salary and dividend distributions taken from the corporation. An unlimited number of owners are possible and common and preferred stock can be issued.
Advantages. C Corporations can go public and solicit foreign investment, and because shareholder count is unlimited, employees can receive stock compensation.
Best choice when owners are most interested in raising capital and feel that their business is poised for public investment. It’s also ideal when cash is tight, as company shares can be offered as part of compensation packages.
Cautions and limitations. The entity is subject to taxation on company profits and the shareholders are subject to tax on salaries or dividends the owners receive from the corporation.

LLC/LLP

Characteristics. These two entities are very similar, although LLPs tend to be professional firms. Liability is limited, and owners can assign the profit/loss weight of each investor according to the operating agreement.
Advantages. There’s no double taxation, as owners only pay income taxes on earnings from the partnership and self-employment taxes on the profits. There can be an unlimited number of members, including foreign.
Best choice when owners wish to attract investors with deeper pockets who want the business tax deduction from early stage operating losses.
Cautions and liabilities. General partners must pay self-employment taxes on profits that the company earns. If there are two owners and one passes away, the partnership is deemed dissolved and a new entity needs to be formed.

Talk to an experienced financial professional to choose the entity that’s right for you.

Contact us at [email protected] or at 973.994.9400.