As a small business owner, one of the most important (albeit often overlooked) decisions that you can make for your company is selecting the legal structure that is the best fit for your needs. In this article, we will outline some of the most popular legal structures for small businesses and highlight the benefits of choosing to elect S Corp status.
Many business owners begin operating as sole proprietorships. However, running your company as a sole proprietorship can be risky, as this does not make a legal distinction between your personal and business assets. Unfortunately, this means that the owner is liable for the debts of the business, which can be extremely dangerous in the event that the business gets sued or goes bankrupt.
Limited Liability Companies
When choosing to move beyond the legal structure of a sole proprietorship, many people choose to form an LLC, or limited liability company. This popular choice is fairly easy to set up, with far less paperwork than some of the more complicated choices, like a C-Corp, but still limits the liability of the business owner, as the name suggests. This structure is flexible and inexpensive, and the protection that it offers the owner is indispensable in the event of hardship within the company.
According to CPA Practice Advisor, a C-Corp provides the strongest protection from business liability. However, it is also the most difficult to establish and maintain, with obligations to elect a board, hold regular meetings, draft corporate bylaws, and establish Articles of Incorporation with the state. C-Corps also pay state and federal filing taxes, making them a more expensive legal structure choice. However, C-Corps allow a business to sell stocks and shares as well as deduct retirement costs and business expenses. A C-Corp is considered a completely separate entity from the business owners, with no effect on the founders or members if the company goes bankrupt or is sued.
If you’re running an LLC or C-Corp, you may want to consider S-Corp status. An S-Corp is not a legal business entity, but rather a designation that you can select for tax purposes. Establishing S-Corp status enables you to benefit from pass-through taxation rather than being taxed as a corporation. An S-Corp still allows you to maintain the liability protection that your chosen legal structure provides.
One of the biggest benefits of an S-Corp is that it also allows members or owners to take a lower salary (on which they pay taxes) and receive further fund from dividends, which are not subject to self-employment tax.
There are several requirements for electing S-Corp status, including the following:
• The business seeking S-Corp status must be a US corporation or LLC
• The company must have fewer than 100 shareholders
• The business must use the Dec 31 year-end for taxes
• The company must only offer one class of stock
S-Corps can have many tax benefits for owners and members if set up properly. If you’d like to elect S-Corp status, you may do so by filing form 2553 with the IRS before the March 15th deadline. S-Corp status can be revoked at any time by holding a shareholder vote. Before making a decision on which entity to select, be sure to talk to your tax and legal advisors. If you need a referral to a legal professional who can guide you on your decision, reach out to us for information.