Starting a business? Great! It\u2019s an exciting time. But it\u2019s also a time packed with questions, hundreds of them, all demanding an answer now. A big one is what kind of business form to use. For help with that, keep reading.<\/p>\n
Previously, I introduced the kinds of legal entities that you can choose for running your business. Those entity types were sole proprietorships, partnerships, corporations, and limited-liability companies. That article focused primarily on the first two. Now let\u2019s take a deeper look at the other two\u2014corporations and LLCs.<\/p>\n
The term \u201ccorporation\u201d calls to mind globe-spanning companies like Apple, Toyota, and Exxon Mobil. But corporations are not limited to the titans of industry. In fact, most are owned and operated by people like you. <\/p>\n
A corporation, unlike sole proprietorships and partnerships, is a legal entity separate from its owners. These owners are known as shareholders. Meanwhile, the corporation\u2019s day-to-day affairs are handled by directors with job titles like president, secretary, and treasurer. For small corporations, some or all of the shareholders are usually also the directors. <\/p>\n
The biggest reason people create a corporation is to limit their liability. Unlike a sole proprietorship or partnership, owners have limited liability for the corporation\u2019s debts. In other words, if the corporation\u2019s business is going badly or it loses a pricey lawsuit, creditors can chase the corporation\u2019s assets but not the shareholders\u2019 personal assets. The only thing an owner loses is the time and money they invested in the corporation\u2014nothing more.<\/p>\n
Consider an example. Al and Bob want to open a coffee shop, the Pacific Caf\u00e9. They set up a corporation with themselves as both the shareholders and directors. They each kick in $10,000 and get a $50,000 loan, all of which is used to buy equipment and secure space. Business is good for a time and they pay back half of the loan plus their original investment, leaving a total debt of $25,000. But new coffee shops emerge, drying up the Caf\u00e9\u2019s profits. And then things get worse: A customer slips on a puddle during a rainstorm, badly hurting herself and leading to a $25,000 lawsuit. If the Caf\u00e9 closes up shop, how much of its $50,000 debt are Al and Bob personally liable for? None\u2014barring several exceptions that we\u2019ll address in a future article. <\/p>\n
One of the prices for a corporation\u2019s limited liability is a heightened level of formality. Corporations need to issue stock, elect officers, and hold regular board and shareholder meetings. They also need to keep meetings of those minutes, follow the Commonwealth\u2019s statute governing corporations, and so on.<\/p>\n
That brings us to everyone\u2019s favorite topic: tax. How a corporation is taxed depends on what kind of corporation you select. There are two flavors: S corporations and C corporations. <\/p>\n
S corporations are treated like partnerships where profits and losses go straight to the shareholders and are reported on each shareholder\u2019s personal tax return. In this version, profits are only taxed once. <\/p>\n
C corporations are different. They pay taxes on all profits and then shareholders pay tax on any money they receive from the corporation. This is often called double taxation.<\/p>\n
If double taxation sounds unappealing, you have a variety of ways to soften the blow. One option is to pick our final entity choice\u2014an LLC. LLCs share the best of sole proprietorships, partnerships, S corporations, and C corporations.<\/p>\n
For one, LLCs enjoy limited liability just like an S or C corporation. Thus, generally speaking, owners of an LLC (known as members) are not personally liable for the LLC\u2019s debts.<\/p>\n
For another, like a sole proprietorship, partnership, or an S corporation, LLCs do not pay income tax. Instead, the LLC\u2019s income \u201cpasses through\u201d the business to each owner, who then pay tax on their personal tax return. <\/p>\n
Careful readers will have noticed that LLCs and S corporations have limited liability and pay no income taxes. If so, you are probably wondering what\u2019s different between the two? Several things. <\/p>\n
First, only U.S. citizens or residents can own an S corporation. But anyone can own an LLC. <\/p>\n
Second, S corporations have to distribute profits according to the percentage of stock each owner holds. LLCs are more flexible; owners can distribute profits in whatever way they agree. <\/p>\n
Third, S corporations need to closely follow corporate formalities to maintain limited-liability protections. LLCs generally just need to make sure that the management team agrees about major decisions. <\/p>\n
And, fourth, S corporations cannot pass business debt to its shareholders unless the shareholder personally cosigned or guaranteed debt (not something I would recommend). LLCs, on the other hand, normally allow for debt to be passed through to its owners. Why does that matter? Because it can mean a nice tax break for the LLC owner. <\/p>\n
So, what should you take away from this article? You have choices. But which choice is best will depend on several factors, ranging from those we\u2019ve discussed like limiting liability and taxes to others we\u2019ll discuss in future articles. <\/p>\n
To make the right choice, invest some time and money on the front to end to speak with both your attorney and accountant. That is doubly true if the business will have more than one owner. An hour of conversation now will pay for itself many times over in the months and years to follow. <\/p>\n
Good luck. (Jordan Sundell, Special to the Saipan Tribune)<\/strong><\/p>\n Jordan Sundell is a lawyer primarily practicing business and real-estate law. He formerly worked for the CNMI Supreme Court and Bridge Capital and is now general counsel for several real-estate companies, including Joint Marketing. His columns\u2014focused mainly on real estate and small business\u2014are published every other Tuesday.<\/em><\/p>\n","protected":false},"excerpt":{"rendered":" Starting a business? Great! It\u2019s an exciting time. But it\u2019s also a time packed with…<\/p>\n","protected":false},"author":11,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[6],"tags":[2943,56,13012,1449],"class_list":["post-292256","post","type-post","status-publish","format-standard","hentry","category-opinion","tag-bridge-capital","tag-business-3","tag-jordan-sundell","tag-llc"],"_links":{"self":[{"href":"https:\/\/www.saipantribune.com\/index.php\/wp-json\/wp\/v2\/posts\/292256","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.saipantribune.com\/index.php\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.saipantribune.com\/index.php\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.saipantribune.com\/index.php\/wp-json\/wp\/v2\/users\/11"}],"replies":[{"embeddable":true,"href":"https:\/\/www.saipantribune.com\/index.php\/wp-json\/wp\/v2\/comments?post=292256"}],"version-history":[{"count":0,"href":"https:\/\/www.saipantribune.com\/index.php\/wp-json\/wp\/v2\/posts\/292256\/revisions"}],"wp:attachment":[{"href":"https:\/\/www.saipantribune.com\/index.php\/wp-json\/wp\/v2\/media?parent=292256"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.saipantribune.com\/index.php\/wp-json\/wp\/v2\/categories?post=292256"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.saipantribune.com\/index.php\/wp-json\/wp\/v2\/tags?post=292256"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}