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Limited Liability Companies (LLCs). The limited liability company (“LLC”) is the most popular form of entity for small business owners for two main reasons. First, the legal requirements of running an LLC are much more flexible, while laws governing corporations are extensive and require a number of formalities to be observed. Some of these formalities include required annual meetings, required assigned officer positions that must be filled by individuals (e.g. President or Secretary), and required disclosures to be made on shares or shareholders. The laws governing LLCs give much more leeway to a business owner to run the business as the business owner sees fit. Second, LLCs are often attractive to small business owners because they are pass-through entities for tax purposes, meaning that the LLC itself does not pay any tax whatsoever. Instead, the profits and losses of the company are passed through to the members. As a result, most small businesses without numerous individual owners prefer the LLC form. To apply for a LLC in Colorado, use the Colorado Secretary of State website to apply. Name requirements have been set by the Colorado Revised Statutes.
Corporations. When, then, does it make sense to form a corporation? As alluded to above, laws governing corporations have stringent requirements that often require the assistance of a lawyer or trained professional. Moreover, standard Subchapter C corporations (as defined in the IRS code) are subjected to double taxation, meaning that the entity is taxed on its income and the shareholders are subsequently taxed on their income from the corporation. However, there are certain situations where a corporation can still be the right choice for a business, including: (i) where the business foresees a need to raise money with investors who would purchase shares; a corporation, unlike an LLC, can reserve shares to be issued to future owners, (ii) where the business owners wish to form a board of directors to manage the affairs of the business, or otherwise run the business more formally (which, not coincidentally, may help attract potential investors as well); and/or (iii) where the business owner wishes to leave significant profits in the business for future growth, as the corporate tax rate is, for many individuals, less than their own tax bracket would be, and thus if profits are left in the corporation, they may grow more quickly than if they were to be allocated to owners and taxed at the owners’ individual rates. To apply for a LLC in Colorado, use the Colorado Secretary of State website to apply. Name requirements have been set by the Colorado Revised Statutes.
Subchapter S Corporations. Subchapter S corporations can be a pleasant in-between for businesses that have future investment and capital concerns that would point them towards forming a corporation but wish to have the benefit of pass-through taxation available to an LLC. However, it is important to note there are limitations on the number of shareholders that can own shares in an S Corporation, and as such it is necessarily more limited than a C Corporation with respect to future growth.
Subchapter S Elections for Taxes: Best of Both Worlds? All individuals who earn income from employment pay Social Security and Medicare taxes. A W2 employee is only responsible for part of those amounts, and their employer pays the remainder. Self-employed individuals have to pay both portions. However, corporations can classify portions of your income as salary (provided that the salary you designate is a reasonable salary for the job) and some as distributions from the corporation. A shareholder would continue to pay self-employment taxes on their salary, but not on distributions, which would only incur ordinary income tax, minimizing tax burden overall. One potential solution to maximize the benefits of the various forms above is to form the entity based upon its needs, but attempt to maximize tax benefit through filing an election for your business to be taxed as a Subchapter S Corporation. Both an LLC or a C Corporation can do so. For an LLC, electing to be taxed as an S Corporation allows business owners to maintain the flexibility of the LLC while avoiding a portion of the self-employment tax as described above. With respect to C Corporations, filing a Subchapter S election can grant corporations the benefit of pass-through taxation.
There is no one-size-fits-all business organization. Any new business owner unsure of how to organize their business, or any business owner not sure if their present entity form is best for them, should consult with an attorney and CPA to see if the grass may be greener elsewhere.
