starting a company

LLC's, and S Corps, and C Corps! Oh My!

Joel Ohman — Thu, 29 Jul 2010 12:00:17 +0000

In the mind of many entrepreneurs, there is nothing more dreaded then spending many of their key start up hours agonizing over which form of business entity is best for their new company. But like Dorothy in the Wizard of Oz, most small business owners have nothing at all to worry about if they prepare and just start down the path. (Yes, I was tempted to say "start down the Yellow Brick Road" but American classic notwithstanding, let's avoid anymore clumsy Wizard of Oz references shall we?)

The First Mistake

One common mistake for many new entrepreneurs is to select a type of business entity for their new business based off of the recommendation of a non-professional friend. Different types of businesses with different goals run by different people may not necessarily share the same type of business entity as an ideal match. When I started a company with informational websites about car insurance, for example, it would not have been smart for me to just assume that I should choose the same type of business entity as a friend's landscaping business. While it is admirable that you understand the importance of forming a business entity, it's also important to know what the right business entity is for your company.

Limited Liability Companies (LLC's)

An LLC is a beautiful thing, because it is so flexible. When forming an LLC, the members have the option to either be treated by the IRS for tax purposes as either:

A Partnership (or a sole proprietorship if there is only one member of the LLC)
C Corporation
S Corporation.

If no selection is made, then the default treatment of the LLC is that of a partnership for multiple member LLC's and sole proprietorship for single member LLC's.

In addition to its flexibility, an LLC also has the added benefit of being cheap to set up, as compared to a C Corporation or an S Corporation. It is important to note that Limited Liability Companies are creatures of the state, and as such, there are some differences depending upon the state where the LLC is formed. For the most part, however, the paperwork requirements for both filing and ongoing reporting are less complicated for an LLC than for a C Corporation or S Corporation.

The last benefit to an LLC is that S Corporations and especially C Corporations have a number of requirements that tend to be characterized as simply corporate formalities. While things like issuing stock, recording stock transfers, and adopting and maintaining bylaws are all very important and serve a useful function in many large companies, chances are good that your typical small business owner is not so concerned with any of these types of things.

S Corporations

You have likely heard of many self-employed individuals raving about the tax benefits of being set up as an S Corporation. Technically a Subchapter S Corporation is exactly the same type of entity as a "regular" C Corporation except for that it has met certain IRS qualifications and has made a special election to the IRS (IRS Form 2553 for those of you who just love to know these types of things).

This special S election is designed specifically for small businesses, as the maximum number of S Corporation shareholders allowed by law is 75 — which is why large companies that are publicly traded are formed as C Corporations and not S Corporations. (Just imagine if Google, Apple, or some other large company in the Fortune 500 with highly desirable stock could only sell their stock to 75 people!)

While there are other differences between S Corporations and C Corporations, it is fairly certain that if you took a poll of tax professionals, they would say that the No.1 "extra special" thing about the S Corporation is its avoidance of "double taxation" that the C Corporation is subject to (which we will get to below). They would also mention the additional tax savings that are available to S Corporation owners. The IRS has stated that S Corporation owners are required to pay themselves "reasonable compensation." After paying themselves "reasonable compensation" the S Corporation owners can take distributions from the S Corporation that are not subject to FICA taxes or Self Employment taxes. The absence of these two taxes can add up to substantial amounts of money for many S Corporations.

C Corporations

C Corporations are the "regular" corporations used by virtually all large companies that have publicly-traded stock. One of the major benefits to the C Corporation form of business entity is the IRS allowance of certain tax free benefits (insurance, travel, etc.) that are unique to C Corporations. An additional benefit is the fact that, whether you plan to sell stock in your company to 30 or 30,000 people, the C Corporation is designed to accommodate those goals.

One of the major negatives of the C Corporation is the aforementioned issue of "double taxation." This means that the C Corporation owes federal tax on the company profit at the corporate level, and once any profits are then distributed to shareholders as dividends, the shareholders each owe federal tax on their dividends received at the personal level.

Some additional things to note about C Corporations, as compared to S Corporations, is that C Corporations can make their profits from any classification while no more than 25 percent of an S Corporation's income may be derived from passive income. C Corporations may issue different classes of stock (common, preferred, etc.), while S Corporations may only issue one class of stock.

Which to Choose?

The standard disclaimer for any and all tax information certainly applies to this article, but in this case it REALLY applies. Hopefully you have learned a few tips and some helpful things to discuss with your CPA, tax attorney, or other tax professional, but above all: Be sure to work with a qualified tax expert so that you can set your company up for success by choosing the right business entity. You will be skipping along in your ruby slippers* in no time at all!

* Sorry, I just couldn't resist!

Guest Post Blurb:

This is a guest post by Joel Ohman. Joel is a Certified Financial Planner™ and the founder of a website for learning more than any one person could ever care to know about car insurance as well as a website for comparing insurance quotes.

This article is from Joel Ohman of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Six Tips to Good Business Management

Nora Dunn — Wed, 16 Apr 2008 22:29:47 +0000

You don’t have to be a fortune 500 (or even a fortune 500,000) company to take advantage of these tips for good business practice. In fact, some of the best small businesses have evolved and succeeded by implementing some of these principles.

I will be using the restaurant industry as anecdotal examples throughout this article, but you will see that the principles below apply to any industry. Maybe you will identify some restaurants in your area that aren’t following these tips. Watch them struggle for business, and ultimately close down as a result.

Know-How is Not Enough.

Just because you’re an expert in your field doesn’t mean that you have what it takes to be a business owner. When you hang out that open sign on day one, it is unlikely that customers will flock to you right away just because you know what you’re doing. You’ll need marketing and administration (at the very least) to grease the wheels of your company.

How many chefs or self-professed foodies have you met or known to open a restaurant because they love food and cooking, only to have it close down months or years later because people weren’t beating a path to their door when they opened? Making good food isn’t enough; people have to know about it to experience it. You also have to run a tight ship financially, which requires the advice of tax and financial experts, and ultimately an experienced general manager at the helm.

Hire the Right People.

If you are technically proficient in your field but lack marketing knowledge and expertise for example, then be prepared to hire the right people to fill in the blanks. This will start the trend of people beating a path to your door. The next trick is to keep them coming back and referring their friends.

Don’t Hire your Friends!

This may seem obvious to some, yet I’ve seen it done over and over again. Not only can it compromise (and in some cases destroy) a perfectly good friendship, but it can do the same to the business.

Sometimes, it works. But hire with caution, and a heck of a lot of communication (both in the friendship and business). Be prepared to wear different hats while at work and after work.

Don’t Make Snap Decisions. Planning Strategy is Everything.

I have an acquaintance who recently stepped in as part-owner of a restaurant. The restaurant is well-situated and ultimately successful, but with a slow-down in businesses in the area, they have to work extra hard to keep enough customers walking through the door and keep them leaving happy.

After one particularly harrowing night when everybody in town decided it was the place to dine and not enough wait staff were scheduled, their patio was drowned out with rain, and one of their head chefs walked out, the owners made some snap decisions during the aftermath. One of their decisions was to double the number of wait staff on shift all the time. It is my feeling that they didn’t truly see this idea through to conclusion before implementing it; they now characteristically have way more wait staff than necessary on shift. The hourly wages paid out are increasing exponentially (and unnecessarily). Each servers’ share of the tips has significantly decreased, and often a number of them get cut before the night is over. The restaurant will likely lose their best servers because of this.

You may say “so? Big deal. Hire more servers,” but servers are the front lines of a restaurant. Poorly trained or inexperienced servers can be the death of a perfectly good restaurant; retaining the good ones is crucial. This was a snap decision may be a critically detrimental one.

Hiring/Promoting From Within isn’t Always Good.

Although promoting from within encourages staff to “reach for the stars” and gives certain personality types something to work for, it isn’t a good idea to categorically hire from within. Sometimes the skill sets just aren’t there within the existing employee base.

A bar/restaurant I know of only hires bartenders from within. If a server has proven themselves with blood, sweat, and tears, they may be so lucky to be promoted to bartender. Sadly though, servers and bartenders are not one and the same. The skills are not transferable, and not all servers understand the finer points of tending a busy bar. Hence, their bartenders are more often than not under-skilled and unprepared for being in the trenches. They don’t have mixology knowledge at their fingertips, they can’t make drinks quickly, and they don’t have the rhythm to manage a fast-paced bar when it gets crowded. They are simply thrown into the fire and made to survive by trial & error or go down in flames, ultimately quitting or being fired.

They are losing business because they insist on promoting servers from within to become incompetent bartenders, instead of hiring proficient bartenders to begin with. And when you’re running a busy bar, a good bartender is an essential element to make things run smoothly.

Good Business is in Consistency.

This could be the very key itself to good business practice. If you do nothing else, be consistent. E-Myth is an excellent book by Michael Gerber centered around this crucial concept.

Consistency is what franchises are built around. McDonald’s pioneered and epitomizes this idea. When you walk into a McDonald’s anywhere in the world, you know exactly what you are going to get when you order a quarter pounder, right down to the exact ingredients, quantities, and order of toppings.

A fledgling restaurant I worked for many years ago liked to think it was fancier than it was. The chef often played around with both presentation and ingredients for their standard entrees, thinking that he was adding variety and constantly improving upon the dish. Unfortunately when I ordered the salmon I never knew how spicy it was going to be, what it came with, and even how it was prepared. You don’t create a loyal clientele or repeat business with discrepancies; you do so with dependability and consistency.

With consistency, professionalism, proper planning of strategies, and alignments with the experts, you can run a top-notch successful business. Don’t reinvent the wheel, or ever find yourself saying “my business is different, I don’t have to follow that rule”. Because the wheel is pretty darn efficient, and I’m sorry to say, your business just isn’t that different. Good business management equals good business. Period.

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This article is from Nora Dunn of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread: