Save 30% on Taxes with the Right Business Entity

When starting a business, an entrepreneur’s most important early decision is choosing the proper legal structure. This decision can have significant tax and liability implications down the road. A corporate business lawyer can help entrepreneurs understand the pros and cons of each entity type and determine the best structure for their unique situation.

Choosing the proper business structure can save 30% or more on annual taxes. It also protects business owners’ assets and allows certain businesses to deduct 20% of their qualified business income. As such an important decision, it pays to consult an attorney skilled in business formations early in the process.

Holon Law Partners has 100+ years of combined experience guiding clients through complex cases and legal intricacies. Our approach is empathetic, customized, and client-centered with a focus on you and your unique business needs. To schedule a consultation with us, call our team at  (866) 372-0726 or email us at: info@holonlaw.com. 

LLCs Offer Advantages Over Sole Proprietorships  

Many new businesses default to sole proprietorships or general partnerships due to the ease of setup. However, these structures offer entrepreneurs little personal asset protection or tax savings. LLCs provide legal and tax benefits sole proprietorships lack while avoiding the double taxation of C corporations.

LLCs limit owners’ liability and allow income and losses to pass through to personal tax returns. Unlike sole proprietorships, LLCs separate business and personal assets to better protect owners. LLCs also gain access to more business tax deductions. Owners can deduct 20% of their qualified business income plus business expenses and depreciation.

C Corporations Subject Profits to Double Taxation

C corporations subject profits to “double taxation” – once at the corporate level and again on shareholder dividends. However, C corps provides more options for attracting outside investors. Companies planning an eventual IPO often start as a C corporation and then switch to an S corp structure. 

C corporations better shield owners from legal liability but have more paperwork and regulations than LLCs. The C corp structure appeals most to large companies needing to maintain separate finances. The increased taxes and regulations often outweigh the benefits for small businesses.

S Corporation Status Offers Tax Savings  

Many small businesses opt for S corporation status to save on self-employment taxes. S corps avoid corporate income taxes. Owners instead report their share of corporate income and losses on personal returns. This allows business profits to get taxed once at rates lower than the 15.3% self-employment tax. 

Companies must meet requirements like having 100 or fewer shareholders to qualify for S corp status. S corps also come with more record-keeping formalities than LLCs. Overall, S corps offers a middle ground between liability protection and tax savings for many small businesses.  

Choose Business Type Based on Goals and Needs

Many factors influence the best legal entity for a business, including goals, risks, and financing options. Business owners should consult business attorneys to determine what type of entity optimizes taxes and liability protection. 

LLCs suit most small businesses needing limited liability protection and pass-through taxation. More complex operations with big growth goals or in higher-risk industries may opt for C or S corps. Corporations allow for more excellent capital raising through the sale of company stock.

LLCs Well-Suited for Real Estate Investments

The LLC appeals to real estate investors because it separates liability between multiple properties. Investors can create a different LLC to purchase and manage each new property. The owner’s other holdings remain insulated if legal action ever targeted one property.

LLCs also mean real estate investors can qualify for the 20% qualified business income deduction starting in 2018. This tax break allows owners of pass-through entities to deduct up to 20% of rental income. Optimizing taxes leads to higher profits and faster ROI from investments.

Weighing the LLC vs LLP Question  

LLCs and LLPs (limited liability partnerships) both offer some liability protection and flexibility. LLPs most often serve groups of professionals like lawyers, CPAs, and architects seeking to limit individual liability. Most small businesses find the LLC structure more suitable for their needs.

Unlike LLPs, state laws allow LLCs to own property, issue ownership shares, and attract outside investment. LLCs better shield owners’ assets from company debts and lawsuits than partnerships. LLCs also avoid the increased registration requirements and fees for LLPs in certain states.

Pierce the Corporate Veil by Ignoring Formalities

Business owners who ignore corporate formalities like holding annual shareholder meetings leave themselves open to litigation. Plaintiffs can “pierce the corporate veil” by proving owners mingled corporate and personal finances or failed to operate as separate entities.

Judges may then assign personal liability to shareholders and allow collection of company debts from their non-business assets. Keeping business and personal affairs separate remains critical even in entities like LLCs with pass-through taxation and fewer formalities. Otherwise, owners risk undercutting, which is a major reason for incorporating.

Pick Location Wisely When Forming an LLC  

A common question from new LLC owners involves registering in the “best” state. The answer ties closely to where the business operates. Establishing an LLC in one state while working exclusively in another jeopardizes owners’ liability protection.

Ideally, LLCs should register in the same state where they rent office space, hire employees, open company bank accounts, etc. If the business has a nexus in multiple states, it may need to register as a foreign entity when crossing state lines. Also, consider whether a state charges income taxes on pass-through entities.

Recognize Multistate Operations and Taxes

LLCs with cross-state activities must follow regulations in each state where they have a nexus. After establishing an LLC in the home state, registering as a foreign LLC in every other state of operation may be necessary. Some states don’t tax foreign LLCs but charge fees simply to operate there.

Working with corporate business lawyers helps business owners stay compliant with regulations tied to out-of-state operations. It also keeps them apprised of changing tax laws in states with income taxes on pass-through entities. Both factors contribute to the costs and tax burdens facing multistate businesses.

Pick a Registered Agent Carefully  

LLCs must designate a registered agent when incorporating. This person or company serves as an entity’s official point of contact with state regulators and for accepting service of process. Many companies opt for low-cost cookie-cutter agents.

However, issues sometimes arise with delays in forwarding time-sensitive documents, limited hours to accept service, frequent agent changes, and communication problems. LLC owners should research options for reputable registered agents to avoid administrative headaches.

Converting an LLC to a Corporation

LLCs wanting to attract VC funding, IPO, or issue company stock often convert to traditional C corps or S corps. They trade pass-through taxation for shareholders and increase access to capital markets. Corporate business lawyers oversee the conversion by filing articles of incorporation, drafting bylaws, issuing stock certificates, holding shareholder meetings, and more. 

Conversions don’t require dissolving the LLC or forming an entirely new company. The LLC contributes assets and liabilities as capitalization to the new corporation. However, C corp status means profits face double taxation. Many companies plan to eventually switch back to an S corp or LLC structure after going public.

Choose Franchising to Grow Brand Quickly

LLCs and corporations both suit franchise businesses, each with some advantages. LLCs involve less paperwork, but C corps can better motivate franchisees through stock incentives. The liability shield and relative simplicity make LLCs a popular initial structure for franchisors.

Expanding through franchised locations lets young companies quickly grow regional or national brands. It transfers much risk and overhead to franchisees while providing recurring royalty income. Franchisors must develop detailed operations manuals, marketing plans, menus, branding, etc. for franchisees.

Failure to Observe Formalities Threatens Protection

LLCs, S corps, and C corps all limit owners’ financial liability provided they follow certain rules and formalities. This may include holding annual member meetings, documenting major decisions, and properly tracking ownership shares called units for LLCs. 

S corps must limit shareholders to 100, have only one class of stock, and issue a Form 2553. C corps face the strictest regulations around issuing stock, appointing director and officer positions, and holding shareholder meetings

Failing to observe these formalities threatens statutory liability protections. Plaintiffs can argue that the owners disregarded the company’s separate legal status from their personal affairs. It risks owners’ non-business assets in any lawsuits or bankruptcy proceedings.

Tie Business Activity to Registered States 

States provide liability protection and favorable tax status to entities that conduct substantive business within their borders. Some underfunded or suspect businesses register in states with only a token physical presence to utilize lax laws.

However, courts can void liability shields or revoke entity status if they sense abuse of a state’s regulations. Tying the location of business activity and assets to an entity’s state of formation better holds up to legal scrutiny. It also avoids issues with triggering tax nexus in multiple states.

Special Rules Aid Service Companies

Service companies like law firms, healthcare providers, CPAs, and consultants form popular professional LLCs called PLLCs. PLLCs follow the same rules as standard LLCs but allow special treatment for partner profits called distributed shares.

State laws prohibit service PLLCs from raising capital like other businesses. Distributed shares give partners profits tied to their ownership percentage, avoiding claims that partner profits constitute dividends on invested capital. Most service providers starting joint ventures default to forming PLLCs.

Mergers Allow Two Companies to Combine

Companies sometimes find combining forces with a competitor better achieves growth goals than going alone. LLCs and corporations can merge by exchanging ownership shares in a negotiated ratio. All assets, liabilities, and equity transfer to the surviving entity.

Company mergers require member or shareholder approval following detailed merger agreements drawn up by attorneys. The agreements address issues like naming board members; ownership splits, executive pay, valuation dates, and the merger timeline. Both companies must dissolve filings with the state upon completing the merger.

Convert to C Corp Before IPO Launch

LLCs looking to raise sizable investments or cash out owners through an IPO first convert to C corporations. Most institutional investors and public shareholders prefer buying stock in traditional corporations. The corporate structure also better accommodates a large shareholder base.

Conversion filings list the LLC as the incorporator transferring assets and liabilities to the new entity. Ownership shares convert according to the LLC’s partnership percentages. The new corporation must issue shares and adopt regulations per state business statutes and securities laws to solicit outside investors.

Choice of Entity Impacts Taxes and Liabilities

As the examples above illustrate, something as simple as legal entity form can have lasting ramifications. Business owners should carefully weigh options alongside attorneys to match the best structure with their goals. LLCs, S corps, C corps, partnerships, and sole proprietorships create different outcomes for taxes, liability protection, and raising capital.

Rushing ahead without fully understanding differences risks tax savings and exposes personal assets. A corporate business lawyer freely guides clients through choosing between pass-through taxation, liability shields, and flexibility – not a one-size-fits-all decision. Selecting properly at startup saves considerable headaches later.

Frequently Asked Questions about Corporate Structure 

1. What is an S Corporation?

An S corporation is a legal business structure that passes income, losses, deductions, and credits through the business to the personal tax returns of its shareholders. It offers liability protection like a corporation with the tax treatment of a partnership. The “S” election exempts qualifying corporations from corporate taxes, avoiding double taxation on distributed profits. 

2. What Is An LLC?

A limited liability company (LLC) combines aspects of partnerships, sole proprietorships, and S corporations into one flexible structure. LLCs limit owners’ financial liability while allowing pass-through taxation like an S corp or partnership. LLC profits and losses pass to owners’ tax returns without facing corporate taxes. State laws govern the protections and operations of LLCs.

3. What Does Nexus Mean For My Business?

Nexus means a business has an official presence in a state, subject to that state’s tax laws and regulations. Any LLC or corporation with employees, offices, inventory, clients, etc., in a state likely establishes nexus. Some states set financial or transaction volume thresholds that trigger nexus and tax liability. 

4. Can An LLC Own A Franchise?

Yes, LLCs make excellent structures for owning and operating a franchised business. The LLC limits owners’ liability if employee, customer, or vendor issues arise. Many franchises require franchisees to incorporate for similar liability and tax reasons. LLCs file fewer formation documents and annual reports than corporations in most states.

5. Can You Merge An LLC With A Corporation? 

Yes, LLCs and corporations can combine through statutory mergers. The most common scenarios involve merging an LLC into a corporation or vice versa. The LLC contributes assets and liabilities as capitalization to the corporation. consult an attorney because unique tax considerations and ownership issues arise when merging different legal entities.

Work With A Corporate Business Attorney At Holon Law

Starting a new business requires weighing many complex decisions during preparations and ramp-up. Only some choices carry the lasting impact of picking an entity type to house operations. LLCs, S corps, and C corps take different approaches to mitigate taxes and risks. 

Holon Law Partners has 100+ years of combined experience guiding clients through complex cases and legal intricacies. Our approach is empathetic, customized, and client-centered, focusing on you and your unique business needs. To schedule a consultation with us, call our team at  (866) 372-0726 or email us at: info@holonlaw.com.