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Start a Small Business
in Massachusetts
Which Entity should you choose?
When you are starting or growing a corporation, some Considerations
should include Taxation, Tax Reporting, Ownership, Personal Liability of Debt, Record Keeping Requirements, Management and Operation, Paperwork involved in Forming the Entity, and Employee Compensation. The following three paragraphs show you the difference between an s corp and c corp,
- LLC
- C Corporation
- S Corporation
LLCForming an LLC
Recommended for owners who want a pass-through income taxation and personal liability protection of a corporation, with less formality. Great for real estate investments and passive income.
Taxation Owners can either opt for the tax structure of a corporation, in which the corporation's income is taxed, or the pass-through
structure of a partnership or a proprietorship, wherein personal income includes business profits and losses and is taxed accordingly.
Taxation Reporting Income Form 1040, Schedule C, or Form 1065 & Schedule K-1 for profit distributions.
Ownership One or more Members.
Personal Liability of Debt Members not usually liable for debts of LLC.
Record Keeping Requirements Annual State Reports.
Management and Operation Flexible similar to a partnership. An operating agreement typically outline management duties. Optional board of managers.
Paperwork State Filing.
Employee Compensation While an LLC may reward employees by offering them membership interests in the LLC, the equity compensation process is awkward and may be unattractive to employees. Furthermore, LLCs are not able to offer certain forms of equity compensation available to C corps., such as incentive stock options.
C CorporationForming a C Corporation
Recommended for owners needing maximum tax and ownership flexibility, combined with liability protection. C corps have well-defined structural accountability, with governance responsibilities held separate and apart from the owners. Management is accountable to the board of directors and therefore has the ability to transact business without stockholder participation in each decision. However, corporations are required to pay attention to formalities that legislatures and courts have determined to be significant (e.g., meetings of boards of directors and maintenance of corporate bylaws, corporate minute books, stock ledger books, separate bank accounts, etc.).
Taxation The earnings of a C corporation are generally taxed twice: once at the corporate level on the corporation's taxable income and a second time at the stockholder level on dividends or distributions. In addition, C corps often must pay higher state franchise taxes than LLCs or S corps.
Although the double-taxation feature of C corps may be undesirable, its impact may be diminished where a company does not pay dividends or generates taxable income at a lower marginal tax rate than the rate applicable to the individual stockholders. If a C corp generates net operating losses rather than net income, these are carried forward to offset future corporate taxable income. However, such operating losses may not be used to offset taxable income of the individual shareholders.
Taxation Reporting Income on Form 1120. Salaries on Form W-2. Profit distributions on Form 1099-DIV.
Ownership Similar to a corporation, an LLC may have an unlimited number of members. However, ownership transferability for an LLC is not as flexible as that for a C corp. Generally, a member needs the approval of other members before selling an interest in the LLC. Also, a death, withdrawal, expulsion, or other departure of a member may constitute a termination of the LLC and a deemed liquidation for federal tax purposes.
Personal Liability Shareholders typically not liable for corporate debts.
Record Keeping Requirements Formal board and shareholder meetings and minutes. Annual state reports.
Management and Operation managed by directors, elected by shareholders. Day-to-day operations run by officers appointed by directors.
Paperwork State Filing.
Employee Compensation Businesses that plan to use equity incentives (e.g. stock options) to attract and retain talent often prefer to operate as C corps. C corps can offer incentive stock option plans that allow employees to defer tax on the equity compensation until they sell the underlying stock. Additionally, C corps. may offer certain fringe benefits to employees that are tax-deductible to the company and also tax-free to the employee.
S CorporationForming an S Corporation
Recommended for owners who want the liability protection of a corporation, with the simplicity of pass-through income taxation. Formal much like the C Corp.
Taxation No tax at entity level. Income & loss passed through to shareholders.
Taxation Reporting Income on Form 1120s. Salaries on form W-2. Profit distribution on Schedule K-1.
Ownership Shareholders (restriction against corporate shareholders, nonresident aliens, and > 100 shareholders)
Personal Liability Shareholders are not usually liable for corporate debts.
Record Keeping Requirements Formal board and shareholder meetings and minutes. Annual state reports.
Management and Operation Managed by directors, elected by shareholders. Day-to-day operations run by officers appointed by directors.
Paperwork State Filing. Subchapter S election with IRS requied within 60 days of formation.
Employee Compensation Although S corps can grant stock options, they should not be granted to non-U.S. residents. S corps are less flexible than C corps with regard to fringe benefits and must either report the benefits as taxable compensation to the employees or forfeit the fringe benefit deduction available to the company.
When choosing the entity type right for you, be sure to consider the future needs and situation of your company, not just its position in the present.
As was said before, there are pro's and con's to each type, but if you consider them carefully, the best fitting entity will likely be clear.
Before doing anything, it is wise to consult with a lawyer and an accountant to have your options clarified and questions answered. Call the law office of
Fred Pellegrini with any questions you may have. 781.329.1060.
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