The Right Business Entity for Your Company

C corporation? S corporation? Limited liability company? Whatever your current legal entity, you may want to make changes this year. The sooner you act, the more options you have.

Consider being C
Most small business owners think that being a C corporation is meant only for publicly traded companies. They'd be wrong.

There is a growing list of reasons to consider being a C corporation:

  • Lower tax rates. Look for tax reform to lower the maximum corporate tax rate from its current 35% rate. This will enable the corporation to accumulate some of the corporation's earnings that can ultimately be harvested by owners at favorable capital gains rates.
  • Access to funding. Starting this year, equity crowdfunding will enable C corporations to raise up to $1 million from numerous small investors.
  • Potential for tax-free gains. There had been a 100% exclusion for any gain on stock acquired in certain types of C corporations before 2012 and held for more than five years. This tax rule could be re-introduced (currently there is a 50% exclusion, which isn't too bad).
If you are now an S corporation and want to terminate this status so that you become a C corporation, either:
  • Do something to become ineligible for S status, such as transferring shares to an ineligible shareholder. This changes the status at the time of the terminating event.
  • File a statement of revocation of S status with the IRS. You can file a prospective revocation saying that you want to terminate the S election as of the end of the current year. Alternatively, you can make a retroactive termination to the start of the year if the revocation is filed no later than March 15 of the current year (for a calendar year corporation). Also, check on steps needed to revoke any state S election.
If you are now another type of entity, check with your tax advisor about making a change. This could entail extra tax filings (e.g., one for a sole proprietorship for a short tax year and another for the C corporation with a short tax year).
 
 
S makes sense
If you are incorporated, S status enables you to avoid double taxation. All of the net income passes through to owners; owners are taxed on their share on their personal income tax returns.
 
If you incorporate now and want S status for your first year, you must make the election within the first two and one-half months of the corporation's year. For example, if you form an S corporation on February 1, 2013, you must make the election no later than April 15, 2013. Find more details in the instructions to IRS Form 2553.

Be sure to note that state income tax rules vary when it comes to S corporations. Check with the laws in your state and factor this in to your entity decision.

 
LLC for me?
While an LLC offers pass-through tax treatment similar to S corporations, there is one important difference. S corporation owners are employees who receive salary from the business; only the amount disbursed as such is subject to FICA taxes. In comparison, LLC members are self-employed; potentially all of their shares of the business' net income are subject to self-employment tax.
 
LLCs can be used effectively by businesses to hold realty. Because of special basis rules, this ownership arrangement provides for greater tax write-offs. Typically, owners of the business form an LLC to hold realty separate from the business; the LLC then leases the property to the business.

B corporations
Whether you opt to be a C or S corporation, you can obtain a special designation as a B corporation. A benefit ("B") corporation is a special type of entity permissible in California, Hawaii, Illinois, Louisiana, Maryland, Massachusetts, New Jersey, New York, Pennsylvania, South Carolina, Vermont, and Virginia. (Bills pending in 14 other states would also allow B corporations.) The "B" differentiates the corporation in three ways: higher standards of purpose, accountability, and transparency.

Get expert advice
This is no place to stint on paying for expert advice. The right entity choice can save taxes, simplify tax reporting, and more -- all of which can far exceed the fees for advice. Work with a knowledgeable tax advisor who can help you determine the best choice for your situation.
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