A corporation is an organization that is legally separate from owners and operators. Similar to individuals’ contracts, loans, assets, and liabilities are all applicable under a corporation. Corporations are also limited liability organizations separating any legal responsibility from owners. That means if a corporation is subjected to a lawsuit or faces financial hardships owners are not liable for any debts incurred. Corporations are recognized internationally, which is another major benefit to them.
Corporations are formed for a variety of reasons, not just to make a profit. Many corporations owned subsidiaries, for example, Alphabet Inc is the parent company of Google. Alphabet also owns Youtube, Android, Waze, and a variety of other organizations.
A C corporation is typically reserved for companies that are hoping to go public one day. In other words, C Corporations are for companies expecting to become large. C Corporations are able to issue shares of stock to owners, founders, employees and investors.
This makes it easy to raise outside capital and if the company is able to go public have an easy initial public offering process. C Corporations like any corporation are recognized on an international scale. C Corporations are also able to issue premium voting shares for the board of directors and other important shareholders.
What is the primary difference between a C Corporation and an LLC? LLCs are recognized on an international scale and have a more flexible management structure than C Corporations. Unlike C Corporations LLCs are not able to issue shares of stock, meaning that LLCs are typically reserved for smaller companies with a single to multiple different owners.
S Corporations are for smaller companies as they are only allowed to have up to 100 owners. Furthermore, owners are only able to get the common stock meaning that there are no preferred voting shares. S corporations are only taxed once but do have ongoing compliance fees. These corporations also require all owners to be U.S. citizens or residents.
S corporation vs LLC? An LLC is able to have unlimited owners, which can be a major attraction for companies that do not want to go public and want to have many different owners. However, you need to have all owners agree to any transfer of ownership, which can present many issues that an S corporation is able to avoid. LLCs are never able to go public, which can put a ceiling on a company if they ever have the desire to go public.
The sharp difference between LLC and any type of corporation is that an LLC has owners. Meanwhile, corporations are owned by shareholders. Additionally, LLC does not require a board of directors like a Corporation. LLCs have the most amount of flexibility when starting a business as it protects personal assets, have minimal paperwork, and can have as many owners as desired.
Meanwhile, corporations have two different classes, S-corps and C-corps. For smaller businesses that have multiple owners a major benefit to an S Corp is that there is a board of directors to avoid management challenges. The primary benefit of an LLC over both an S Corporation and a C Corporation is flexibility. The drawbacks are the ongoing fees, not being able to reinvest profits, and the challenging management structure.
Normally anytime an asset is sold, it is subjected to capital gains tax. Capital gains tax is applicable to businesses being sold, stocks, bonds, jewelry, and real estate. For example, let’s say you invested $1,000 in stock and sold it five years later for $2,000. You will be subjected to a 0%, 15%, or 20% capital gain tax, depending on your income level.
Most people find their capital gains tax to be below 15%. In this example, let’s assume that your capital gains tax is 15%, which means that of your $1,000 profit you will be responsible for a $150 federal capital gains tax on top of any state and local taxes. This means that you will walk away with an $850 profit with your initial $1,000 before any state or local taxes. While this example is of stock investment, capital gains taxes apply to any type of asset.
Let’s dive into what happens when you sell your business assuming that you are not a C Corporation. A major benefit of selling an LLC, or S Corporation is Sec 1202 of the United States Tax Law. This allows small businesses to be excluded from capital gains taxes from the sale of small businesses. This maxes out at any amount greater than $10 million.
For example, let’s assume you invest $200,000 to get your new business off the ground. You end up having tremendous success and several years later you sell the business for $7 million. This means that you are exempt from any federal capital gains tax. Congratulations, not only did you find tremendous success, but you were able to save money in taxes.
However, what if you sell a C-Corporation? C Corporations, since they are designed to be larger corporations are not eligible for these tax breaks. If a C Corporation is sold, it will be subjected to standard corporate tax structures which normally come in at 34% – 39%. This is a major factor to consider when filing for what type of business you want to be.
If you are planning to open a large corporation and possibly go public one day, a C Corporation makes this process the easiest. It allows an unlimited number of shareholders, creating gateways to outside capital. Furthermore, if a Corporation sells its assets they are taxed with capital gains. If these gains are then distributed to owners then they are taxed again, which is referred to as double taxation.
This truly depends on what your long-term goals and financing options are. LLCs are easy to set up and are super flexible. However, they have many limitations just as C and S Corporations. If you are hoping to go public C Corporation is the way to go, but if you sell there will be major tax implications.
However, LLCs and S Corporations are more similar and each has advantages over the other. It is important to evaluate the pros and cons of each and consult the team around you before making the decision.
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