As you are working to start your business, one piece of the puzzle is deciding what type of entity your business will be. There are many different types of entities, but for most entrepreneurs, their options generally come down to limited Liability Corporation (LLC), a Limited Partnership (LP) or an an-Corporation. Which one is right for you depend on a number of factors?
If you’re considering an LLC, LP or S-Corp, the first thing that comes to mind is likely how much money it will save you in taxes. While that’s true to an extent, there are other very important considerations when deciding which entity suits your needs best.
In this article, I will discuss the top three things to consider when deciding between an LLC, LP or S-Corp
1. Limited Liability for Your Personal Assets
There are many benefits to incorporating your business in Delaware for tax purposes, but one of the most important benefits is limited liability protection. This means that even if you make a mistake and your company fails, you generally will not be personally liable for the company’s debts and obligations.
If your business is an LLC or an LP, this limited liability protection carries over into and covers personal lawsuits and other claims against you. So even if someone sues you because of something that happened at work, they can’t get to your personal assets. In other words, your house, car and savings are safe from creditors or plaintiffs who come after you for money. This is one of the biggest reasons people incorporate their business to protect themselves personally says William D King.
2. Taxation
Taxes are inevitable for any company doing business in the U.S., but there are significant differences between an LLC, LP and an S-Corp in terms of how they are taxed.
For a standard LLC, the company is taxed as a “pass-through” entity for federal tax purposes, which means that the company’s profits or losses pass through to your personal taxes in much the same way a schedule C business would be treated on your individual returns.
An LLC is an excellent choice if you plan to either be the only employee or else share profits with one or two employees.
For a limited partnership, there are no tax consequences for the company itself. Instead, the individual partners (whether they are individuals or other companies) pay taxes on their proportional share of any profits made by the partnership.
A single-member LP (which would be taxed as a disregarded entity) can make sense for someone who wants to start out small and keep things simple before adding more owners later on (Note: adding new partners will require working with legal counsel). But it is important to note that this option has many disadvantages in terms of liability protection, so it’s most often used by entrepreneurs who want one foot in the proverbial “LLC camp” but are not ready to take that full plunge.
An S-Corp, like an LLC or LP, is a pass-through entity for tax purposes (i.e., profits and losses pass through directly to shareholders). The primary difference between an S-Corp and an LLC or LP is that an S-Corp can only have one class of stock and it must be common stock (which means no voting rights). Most small businesses usually don’t meet this requirement and therefore find they need to either convert the business into a C-Corp (see below) or else use an LLC/LP instead. This can make setting up as an S-Corp more costly than necessary because you will generally need legal counsel to make sure you are set up correctly.
3. Ownership
LLCs, LPs and S-Corps all offer limited liability protection for business owners, but there are significant differences in how ownership is structured.
An LLC has one or more members (owners) who can be individuals or other businesses called “member-managed” if the company will be member-managed then an Operating Agreement must also be filed with your Articles of Organization. The members can contribute however much they want to the capital of the company, which means that an LLC can have just one owner or 100 owners, so long as each owner contributes some capital. And though it’s possible for an LLC to do so, it’s not very common for an LLC to issue different classes of stock to its members.
The primary benefit for an LLC member-owner is that the company profits will flow directly through to them on their personal tax returns without any additional filings or restatements.
An LP also has one or more partners (owners) whose liability protection is the same as an LLC’s, but there are two key differences in how ownership is structured. First, a partner must contribute a minimum amount of capital to the partnership—unless they take on debt instead of cash – and these contributions can be made over time. Second, before receiving their share of any profits from the partnership each year, all partners are entitled to a “distribution” from the prior year’s profits (which means if there were losses last year you’ll have to make up the difference).
The primary benefit for an LP partner is that their share of this minimum capital contribution is considered a guaranteed distribution, meaning it can’t be used by other partners to cover partnership expenses. If the business takes off then they will eventually see increased profits, but they are also responsible for any losses—which are distributed in proportion to each partner’s interest in the company—and so they need to contribute more capital if needed.
Conclusion by William D King:
Lastly, an S-Corp has one or more shareholders (owners) with limited liability protection, but there are two key differences in how ownership is structured. First, shareholders do not have individual tax consequences from the corporation itself because all profits and losses pass through directly to them on their personal tax returns. Second, shareholders are not required to make a capital contribution because the corporation is allowed to deduct its operating expenses from business profits before distributing any net income to shareholders.