Basic things to know if incorporating your business

There are a few options when deciding to start a new company. Deciding on the right entity type to incorporate your business as is an important step and can have long term tax and liability consequences. If you are new to incorporation entities here are a few basic terms to know.

LLC is a simple entity very common with small businesses. An LLC can be owned by a single member or by multiple members. For tax purposes an LLC is a transparent entity. In other words the LLC does not change the way you are paying taxes. The LLC income is funneled and added to its members personal income. The reason to establish an LLC is liability. LLC does provide liability protection to its members but it is not as strong as the protection corporations provide and it depends on the type of business, number of members and the way the LLC is managed.

S-Corp is a simple version of a full blown C-Corp company. S-Corps are not separate entities for tax purposes. In other words the S-Corp income is also funneled and added to the owners personal income. This allows saving employment tax on that income but there is one caveat. You can not transfer all of the S-Corp income as personal income. You must first pay a reasonable wage to the S-Corp offices and workers and only the amounts on top of that reasonable income can be directly transferred as personal income. Those wages will be subject to employment tax, medicare, social security and so on. As such if the projected income from the business is low S-Corp does not provide a tax benefit.

C-Corp is a separate taxable entity. Any income is first taxed at the corporation level and only then can be disbursed to the shareholders and added to their personal income fr further taxation. This can be used to your advantage though in what is know tax splitting. For example if the C-Corp is paying a wage to the owners than that wage is a deductible expense and the C-Corp is not taxed for it. Slitting income means that some income is taxed personally and some is left in the company and paid by the company. In this method more dollars can benefit lower tax bracket. There is a limit though to how much money can be split this way as the IRS set a limit to the wage an owner can take from a C-Corp and still enjoy the full deductible expense. The biggest tax disadvantage of a C-Corp is that if you accumulate money in it and wants to distribute it as dividends that money will be taxed twice first at the C-Corp level and then at the personal level as dividend income.

Before choosing the right entity for your business sit down with your attorney and accountant and think it through. You will need to project things like how many owners will the business have, what is your relationships with them, what is the projected income in the next few years, what is the liability exposure of that type of business and so on.