corporate

June 9, 2020

What’s the Difference Between a C-Corp, S-Corp, and LLC?

Incorporating a business is the process of forming of a new entity that is recognized as a separate “person” under the law. At the very early stages of your business, you will need to decide which entity is the best fit for your purposes. This is often overwhelming for founders and first time business folks. The three types of entities discussed in this article (C corporation, S corporation, and LLC) all partially shield the individual owners from certain types of personal liability. They each have varying benefits regarding fundraising and stock option grants. They also each result in different tax implications or benefits, and provide your company with greater credibility among investors, clients, and customers.

Some Legal Implications of Incorporating:

  • Partial protection against personal liability: A corporation or limited liability company (LLC) partially shields individuals (stockholders, directors and officers) from business liabilities such as loans, accounts payable, and legal judgments. We use the word “partially” because some courts have decided against completely shielding individual owners from personal liability, depending on their behavior and knowledge of the matter. On the other hand, the assets of the corporation or LLC may be protected if an individual is involved in a personal lawsuit or bankruptcy.
  • Transferable ownership: Owners of a corporation or LLC may easily transfer ownership interests to others, depending on state requirements and their own company agreements or bylaws.
  • Conversion: Depending on the rules of the applicable state statutes, one type of business entity may be converted to another (for example, an LLC to a corporation) and may even be transferred to another state (i.e. from California to Delaware). Read a short Lloyd & Mousilli article on conversion if you’re considering starting with an LLC: LLC Now, Corporation Later?
  • Taxation: Corporations are typically taxed at a lower rate than individuals. Corporations may also own shares in other corporations and resulting corporate dividends can be partially tax-free. If you have any doubts or want to explore tax questions, you should speak with a tax advisor. Our firm does not provide tax advice.
  • Duration: Either an LLC or a corporation may continue indefinitely and beyond the lifetime of its owners.
  • Raising capital: A corporation may raise funds by issuance of convertible debts and sale of stock. An LLC may raise funds by issuing membership interests.
  • Employee incentives: A corporation may issue incentive stock options to employees as a form of compensation for their work and tenure. A similar structure may be created for an LLC, but it is typically more complicated and more expensive to manage and setup.
  • Credit rating: A corporation acquires its own credit rating unassociated with the owner’s personal credit rating, even though the owner may be asked to provide some collateral or personal guarantee at times, especially early on after formation.

C Corporations

A C corporation is the standard corporation structure. An S corporation is a corporation that has elected special tax status with the IRS. Both of these corporate entity statuses share the following:

  • They have shareholders, directors and officers.
  • Both are required to follow the same internal and external corporate formalities and obligations, such as adopting bylaws, issuing stock, holding shareholder meetings, filing annual reports, and paying annual taxes and fees as required by state law.
  • Articles of Incorporation are the same for both C and S corporations.
  • Both C corporation and S corporation ownership is transferred by the selling of shares.

The advantages of C corporations are:

  • Investors typically prefer this form of corporate structure when investing in accelerated growth tech companies due to multiple classes of stock available to C corporations, especially preferred stock. Preferred stock provides preferred returns and further protective provisions.  
  • C corporations are also a more favorable setup for employee compensation. A company creating incentive (via stock options) to attract and keep talented employees often prefer C corporation status. C corporations may allow employees to defer tax status on the equity compensation until they sell that initial stock by offering incentive stock option plans, variations of which are possible, but more complicated, in an LLC. Tax-free and tax-deductible benefits are also available to employees in a C corporation (again, check with your accountant on all tax matters).
  • C corporations allow the owners to take advantage of certain provisions in the tax code with respect to exclusion of a certain amount of capital gains and the deduction of certain losses. However, please check with your accountant with respect to these benefits.
  • Non-US citizens or and non-residents are permitted to be shareholders / founders of a C corporation.
  • Since ownership is unrestricted, C corporations are often the best choice for large companies that are or plan to be publicly traded.

The disadvantage of a C corporation is double taxation:

  • FIRST at the corporate level on the corporation’s net income.
  • SECOND to the shareholders when the profits are distributed, if corporate income is distributed to business owners as dividends.

When a corporation is originally chartered by the state, it exists as a C Corporation. It will remain a C corporation unless the company wishes to elect S corporation status.

S Corporations

The main difference between a C corporation and an S corporation is the taxation structure. S corporations only pay one level of taxation: at the shareholder level. To choose S corporation status, a tax lawyer or accountant may assist with filing IRS Form 2553 and ensuring all S corporation guidelines are met. Since S corporation election is not required at the time of incorporation as a C corporation, a company may wish to momentarily hold off on S corporation election in order to consult with an accountant or tax lawyer.

Startup companies will choose an S corporation if the founders wish the benefit of a flow through tax treatment. In other words, a founder can include business losses on their personal tax returns as deductions, which may be particularly attractive during the early stages of a company. A startup can elect S corporation status before the financing stage and revoke S corporation status at the time of a financing. However, S corporation status prevents a startup from having entity (other corporations or LLCs) or non-US citizen/resident stockholders.

The disadvantages of S corporations, unlike C corporations, are:

  • Limited ownership to 100 shareholders, who cannot be non-resident aliens, nor can S corporations be owned by other corporations.
  • An S corporation cannot have multiple classes of stock.
  • S corporations are not allowed to conduct certain types of business. Banks and insurance companies are not eligible for S corporation status.
  • S corporations are less flexible than C corporations for employee fringe benefits.
  • S corporations must report employee taxable compensation.

Limited Liability Companies

A limited liability company (LLC) blends elements of partnerships and corporate structures. An LLC is an unincorporated association that protects the liability of a company.

Startup companies often avoid LLCs because most technology startups seek to grant options to employees and consultants, and it’s very difficult to get professional investors interested in investing in an LLC. LLCs provide no standard or easy way to grant such options. A startup may convert from LLC status to a C corporation but, depending on the state, there may be statutory limitations or additional requirements in doing so. Consultancy and bootstrapped businesses, on the other hand, are often the best choices for LLC status.

Benefits of LLCs:

  • Flexible management structure. Unlike corporations, LLCs are not required to comply with a formal management structure.
  • Like the C corporation, LLCs have no ownership restrictions and members of an LLC may be non-US citizens and non-resident aliens.
  • Flexible tax regime. An LLC can elect to be taxed as a sole proprietor, partnership, S corporation or C corporation. Using default tax classification, profits are taxed personally at the member level, not at the LLC level.
  • LLCs can be set up with just one natural person (in some states) and thus partially separates the liability of a company from that member.
  • LLCs can offer membership interests in the LLC to employees.

Disadvantages of LLCs:

  • Investors may be wary of the LLC structure and prefer the traditional corporate structure of a C corporation or S corporation. This can make raising capital difficult for LLCs.
  • Many states levy a franchise tax on LLCs, which is essentially the fee to pay for the privilege of the LLC status.
  • Renewal fees may also be higher than a C corporation or S corporation.
  • LLCs are not considered corporations for the purposes of civil procedure. Instead, LLCs are treated as partnerships by the courts. This affects diversity jurisdiction. Thus, if a member of an LLC is a citizen of the same state as a member of the opposing party, the LLC may not remove to federal court under jurisdiction (whereas the corporation can).
  • The equity compensation process for employees is not straightforward and standard incentive stock options employed by C corporations are not typically available.

You should consult with the Lloyd & Mousilli team if you have any doubts about the appropriate entity type for your business.

What’s the Difference Between a C-Corp, S-Corp, and LLC?
June 30, 2020

Can I Form an LLC In a State I Don’t Live In?

Several states actively compete for new business formations. The most popular, in no particular order, are New Mexico, Nevada, Delaware and Wyoming. Each state competes for a different part of the market and, unfortunately, there are many misconceptions.

The goal is to find the state which works for you. Below is a guide to how the states differ when it comes to price, privacy and asset protection.

What is the best state to register an LLC?

Everyone is different, but we find the low cost and simplicity of a New Mexico LLC often make the difference for business owners.

Here is a brief overview of your options with a lengthier analysis further down:

New Mexico: With NM, you enjoy all the benefits of an LLC at a fraction of the usual cost. New Mexico acknowledges the corporate veil and provides the same limited liability as other jurisdictions. There are no annual fees or annual reports. In other states, periodic reporting is really just an excuse to collect fees on businesses. New Mexico skips this step, saving you time and money.

Delaware: DE is most famous for its Corporations. They offer hundreds of years of well-defined corporate case law to act as precedent. For large corporations such formalities are important. Small businesses do not benefit from these corporate laws however. The only difference most owners will notice are the significantly higher fees that Delaware levies on its companies. Their LLCs offer privacy, too, but are simply not worth the extra cost versus the other three states we cover. See Why Do Startups Incorporate in Delaware?

Wyoming: WY is a haven for asset protection. There are a number of debtor friendly laws for those seeking protection from personal creditors. These protections come at a price, however. Wyoming’s filing fee is twice that of New Mexico’s, plus there is a $50 annual report which must be signed by someone. This means if you want true anonymity, then you are stuck paying for an additional nominee service to handle the filing each year.

Nevada: NV is similar to Wyoming in being a haven for asset protection. They have a well-developed brand and their Secretary spends considerable sums on advertising the benefits of moving your company to Nevada. They have levered this brand value by increasing fees for eight straight years. This makes Nevada’s LLC one of the nation’s most expensive to start and maintain, just behind California. The Secretary also requires a list of members and managers which they do not publish… yet. In short, Nevada is not the best state for LLC privacy, it is the worst among these four.

Which of the above states appeals to you will depend on your situation. You may even select different states for different companies and operations. Large corporations will enjoy the familiarity of Delaware, asset protection specialists will utilize Wyoming, and those wanting a simple and inexpensive solution should choose to form an LLC in New Mexico.

Why Choose New Mexico?

New Mexico is best suited for small businesses, cost conscious investors and privacy minded individuals. They are a good fit for internet businesses, consulting, real estate and other location independent businesses.

Price: New Mexico LLCs are the cheapest anonymous LLC in the USA. There are no annual reports which saves hundreds of dollars over the life the company. You only need to maintain a registered agent in New Mexico.

Privacy: Members and Managers are not listed. Only the Organizer (us) has to list their name. With no additional annual reports there are also no additional chances for your name to be exposed or nominee services to pay for.

Asset Protection: New Mexico companies offer the same corporate veil as other states. This means you are not personally liable for the company’s debt - hence the “limited liability” in limited liability company.

With New Mexico, you enjoy all the benefits of an LLC at a fraction of the usual cost. In other states, periodic reporting is really just an excuse to collect fees from businesses. New Mexico skips this step, saving you time and money. The state is not well suited for large corporations, however. If you are a large company, then you should consider Delaware or Wyoming.

Why Choose Delaware?

Delaware offers over a hundred years of well-defined corporate case law to act as precedent. They also have a dedicated court system for hearing business disputes called the Court of Chancery. This court system which ensures cases are heard quickly. However, if you a creditor is pursuing you, then the last thing you generally want is a fast track trial. They also do not have as favorable of asset protection laws. This combination makes Delaware ideal for large corporations, but not for small business.

For large corporations such formalities are important. It is also important to have a dedicated court system for complex matters. The only difference most small business owners will notice are the significantly higher fees that Delaware levies on its companies.

Price: There are several hundred dollars in fees, including a $300 annual franchise tax. The Secretary fee to change registered agents is $50. Again, large companies may not notice these fees, but small companies certainly will.

Privacy: Delaware allows anonymity and nominee officers. There are cheaper ways to obtain anonymity, though (New Mexico).

Asset Protection: Delaware companies offer the same corporate veil as other states.

You can obtain the benefits above for a much lower price elsewhere. Delaware has obtained a certain mystique because of the large corporations which reside there. However, you should not believe that Bank of America has the same needs as an entrepreneur. Find out more on Delaware Post Incorporation and Checklist here.  

Why Choose Nevada?

Nevada limited liability companies are among the nation’s most popular. This is due to great their asset protection features and even better marketing. Nevada remains one of the most popular states, but their sky-high fees have many second guessing.

Price: There are several fees to start an LLC, not all of which the Nevada Secretary of State is up front about. You may be mistaken into thinking they only charge $75, but within 30 days of filing you must pay additional fee, e.g. members/managers list and a business license tax.

Privacy: The same as the other states, anonymity is allowed. However, a list of Members and Managers must be provided to the Secretary. There is nothing to stop them from releasing this information at a later date, or suffering from a hack which would disclose this information inadvertently.

Asset Protection: Nevada became popular because of its asset protection. They provide the same corporate veil as other states, but also provide asset protection from personal creditors. Assets inside the LLC are not as easily accessible to creditors as personal assets.

The Nevada LLC certainly earned its popularity early on. Years of continual price increases have eroded its value however. Having to spend money before registered agent fees is an expensive pill to swallow. Those needing personal asset protection are often advised to consider Wyoming.

Why Choose Wyoming?

Wyoming companies have become popular as Nevada became less competitive. Wyoming does not market as extensively and is less well known. They also have a less developed financial system which can make establishing a bank account difficult.

Price: Wyoming charges $100, twice New Mexico, to form an LLC. They also charge $50 each year after and there has been talk of raising it. Plus, the annual report

Privacy: Wyoming does not list owners, managers, directors etc. There is an annual report which asks the name of the filer, thus necessitating the use of a nominee – further raising costs.

Asset Protection: Wyoming offers asset protection similar to Nevada.

Next Steps

While the choice of which state to form your LLC in is personal, you can always seek advice from your Lloyd & Mousilli team. Book a free consultation call here.

Can I Form an LLC In a State I Don’t Live In?
May 12, 2021

Can California residents register an LLC for an online business in a state they don’t live in?

Texas

  • Price: The cost of registering an LLC in Texas is more than three times the cost of registering an LLC in California. Texas LLC Certificate of Formation has a one-time cost of $300 for filing through mail or $308 for online filing. Texas also requires the designation of a Registered Agent, with a Texas address, to receive legal documents for the LLC. California residents planning on registering an LLC in Texas should expect to pay about $125 per year for a Commercial Registered Agent.
  • Ease of Registration: Like most states, Texas allows online filing and filing through the mail.
  • Privacy: Texas does not maintain any information on the ownership of a LLC, except records of the LLC’s registered agent and registered office address.
  • Asset Protection: Texas is an exception to the traditional corporate veil rules, and instead follows the ‘actual fraud rule’. Under this rule, owners or members of the LLC cannot be held liable for corporate obligations unless they used the LLC to commit actual fraud.

Delaware

  • Price: Between Texas, California and Delaware, Delaware is the most expensive state to register an LLC. The costs of registering an LLC in Delaware often outweigh the benefits a smaller business can expect to receive. The initial one-time filing fee is $90 ($99 for a 24-hour turnaround). Like Texas, California residents can expect to pay up to an additional $100/year for a Commercial Registered Agent. Delaware also requires all Delaware LLCs, regardless of their principal place of business or size, to pay an additional $300/year for the Delaware Franchise Tax.
  • Ease of Registration: Like most states, Delaware allows online filing and filing through
    mail.
  • Privacy: Delaware allows anonymity and nominee officers.
  • Asset Protection: Delaware companies offer the same corporate veil as other states.

The high costs associated with registering and maintaining a Delaware LLC often make it a less than ideal choice for new entrepreneurs. Find out more on Delaware Post Incorporation and Checklist here.

California

  • Price: The cost of filing articles of organization in California is $70. There is an additional $20 fee to file a Statement of Information, which needs to be filed every two years. California residents can appoint themselves as registered agents for the LLC instead of paying for Commercial Registered Agents.
  • Ease of Registration: Like most states, California allows online filing and filing through
    the mail.
  • Privacy: California allows anonymity and nominee officers.
  • Asset Protection: California companies offer the same corporate veil as other states.

Will an LLC registered in Texas/Delaware still need a foreign qualification in California if most of the staff and customer meetings will be in California?

Any LLC registered in a state other than California is a foreign LLC and would need a foreign qualification in California in order to transact intrastate business in California. California law classifies transacting intrastate business as the physical presence of company officers, employees, offices, or other facilities within California or if the business plans to develop extensive commercial relations within the state over a long period of time. However, your business does not need to be registered in California if your only connection to California is hiring independent contractors located in California.

You may not have any option other than registering your LLC in California or registering it as a foreign LLC in California if your online business hopes to solicit customers in the state. Failure to register in California can bar businesses from bringing lawsuits in the state. The inability to utilize California’s court system can be particularly detrimental to online businesses with valuable intellectual property prone to infringement. If you wish to register as a foreign LLC in California, then you must provide the same information needed to create an LLC in your state of incorporation and pay all the fees required to register and maintain an LLC in California.

Can California residents register an LLC for an online business in a state they don’t live in?