What is an LLC, S Corp C Corp LLP and why would a small biz incorporate?
If you are self-employed or run a small business you might think it’s crazy to incorporate. You might think your profits are not high enough, or you don’t have enough staff, or that it costs too much. And for some people and businesses, you might be right – incorporating is not the best approach. But for others there are benefits, regardless of the size of the business.
Before going any further, it’s important to point out that this article is not legal advice. We are experts in website hosting, domain registration and everything else that helps small businesses get a presence online. We are not attorneys but you should speak to one before making any decision on changing the legal formation of your business.
That said we do deal with a lot of small businesses. So we designed this guide as a starting point for you to go on to further research and discussion.
What are the advantages and disadvantages?
One of the problems with looking for advice online on whether or not to incorporate is that most resources will tell you to do it. This is because most of them have a financial interest, i.e. they sell services to incorporate your company.
To get some balance, let’s start with the disadvantages:
- In some circumstances getting finance is more difficult. This applies when raising equity capital or using debt capital.
- There are legal requirements like filings, meetings and other formalities. In other words, there is added bureaucracy to follow and bureaucracy often means higher costs.
- There are initial set up costs.
- Some conditions imposed by states might not suit your business.
Now what about the advantages of incorporating? Here are the upsides:
- Personal protection from any liability for company debts or other obligations.
- Transferring ownership is much easier.
- Corporations exist as an entity so they have an unlimited life.
- There are tax benefits in some circumstances.
- In most situations it is easier to get finance for the business.
Finally there is the issue of credibility. Some people think that incorporated businesses have more credibility with customers, contractors and suppliers. This is true in some situations but there are also many businesses that are not incorporated but still have credibility to spare. In some industries and niches being family run or being a part of the community is much more important to customers than any legal structure. Only you will know what’s best for your business.
Now let’s look at some of the options you have to incorporate your business:
LLC – Limited Liability Company
An LLC is a simple legal structure that suits many businesses. This includes those with a single owner and few employees up to much larger operations. The main objective of an LLC is to remove liability for actions or debt of the company away from you. As a result those liabilities rest solely with the company.
S Corp – S Corporation
An S Corp offers the same liability protection for you personally as an LLC. The difference between the two comes down to tax. The income and expenses of an LLC end up in the personal tax return of the owner. In an S Corp your business effectively pays you a salary and you pay taxes as normal on that income. The benefits of an S Corp kick in when you have extra profits. In an LLC extras profits are part of your salary so you’ll get taxed like everything else. In an S Corp extra profits are treated as dividends which are taxed less. Therefore in some circumstances S Corps have a tax benefit.
C Corp – C Corporation
The main difference with a C Corp and the other options is again to do with tax. An S Corp and an LLC treat tax differently but the responsibility for tax on the profits of the business still remains with the individual owners. A C Corp is different because it is taxed, i.e. the income does not pass through to the owners like in the other two examples. A C Corp is the structure adopted by most large businesses with multiple shareholders.
LLP – Limited Liability Partnership
An LLP is similar to an LLC although there are differences, particularly in relation to liability. There are circumstances where the owners of an LLC are held liable for the actions of the LLC, for example if there is a case of fraud. An LLP offers protection against this by limiting the liability of each partner. So in an LLC if a partner commits fraud you might be held liable because the whole LLC is held liable. In an LLP only the partner who committed the fraud is held liable.
The type of business structure that is right for you will depend on a lot of things. This includes the level of income, the liabilities that exist in the business, the number of owners involved and the future plans and direction. This all needs to be considered before you make any decision.