I am sure the author of this article intended to help others make wise tax/entity formation decisions but many of the facts mentioned are just incorrect (tax rates and some general tax concepts). C-corps are fairly uncommon nowadays and for good reason You are almost always going to pay more tax in the C-corp and you will face built in gains issues when you realize this and decide to elect to be an S-corp.<p>The tone of the article seems to be slightly rushed and frustrated and leads me to wonder if the author just received unexpected news from his accountant.<p>One example:<p>Using 2013 tax rates and assuming that the taxpayer is single:<p>Individual Federal income tax on taxable income of $90,000 (ignoring personal deductions/exemptions/itemized deductions, etc..) that the example taxpayer in the article might have to pay if they were a 50% partner/member in an LLC:<p>Roughly $18,493 (less than 21%)<p>Corporate Federal income tax on $100,000 if you and your partner had a C-corp instead and took 40k salaries then left $100k in the company.<p>Roughly $22,250 (About 22%)<p>But then if you end up not spending that money because you made a boatload of cash the next year and want to take it out:<p>$3,337 (15% capital gains)<p>leading to a rough total of $25,587 (over 25.5%).<p>You might look at this example and say "hey that's just a few %" but as the income in question grows, so does the gap.<p>Edit: The real reason startups might end up as corporations is for the beneficial tax treatment investors can receive as holders of small business stock (1202, 1244).
Being in a higher tax bracket doesn't lead you to pay more tax on your initial income, only a higher rate on money above a certain threshold. That said, the article is right in that an S-Corp or LLC sound right and are rarely a good idea because you sometimes lose out on certain tax deductions because your personal income is too high. Remember though, a tax bracket is a sliding scale... see the margin tax rates table at <a href="https://en.wikipedia.org/wiki/Income_tax_in_the_United_States" rel="nofollow">https://en.wikipedia.org/wiki/Income_tax_in_the_United_State...</a>
It's a little more complicated than that:<p>> An LLC with either a single member or more than one member can elect to be classified as a corporation rather than be classified as a partnership or disregarded entity under the default rules discussed earlier. File Form 8832, Entity Classification Election, to elect classification as a C corporation. File Form 2553, Election by a Small Business Corporation, to elect classification as an S corporation.<p><a href="http://www.irs.gov/publications/p3402/ar02.html" rel="nofollow">http://www.irs.gov/publications/p3402/ar02.html</a>
With all due respect, this article really isn't that great.<p>Here's the real difference, stated succinctly:<p>LLCs and S-corps are pass-through entities that aren't generally subject to regular corporate income tax like C-corps are. (But there are exceptions, like NYC, which taxes S-corps as if they were C-corps.) Additionally, C- and S-corps can issue stock to owners and investors, while LLCs cannot, but S-corps are restricted in various ways that C-corps are not, like not being able to issue stock to foreign investors, having only one class of stock and no more than 100 stock owners.<p>VCs and Angels will not invest in an LLC, and the process to convert an LLC to C-corp is (or was, last time I checked) difficult, typically involving the formation of a brand new C-corp that buys the LLC and then dissolves the assets of the LLC into itself. I believe Joel once mentioned that FogCreek went through this process years ago, and it was not very pleasant. By contrast, it is trivial to convert an S-corp to a C-corp with one form (IRS Form 1120).<p>If you ever plan on issuing stock or taking outside investment, start out as a C-corp or S-corp. If you plan on running a business that won't (or can't) issue stock or accept outside investment (like a law firm or medical practice), then form an LLC.
This is an aside, but needs to be said: if you're going to offer a mobile specific layout for your website, test the damn thing first. It's extremely jarring to have share buttons on the left side covering up the first letters of each line. I can't even zoom out so that the text fits. If you're really so desperate for people to talk about your post that you'll cover up the post in order to achieve that, at least put it at the top.
What isn't mentioned here is that an LLC is relatively straightforward to set up, an average Hacker News reader could set one up in their state with a few hundred dollars and no lawyer. S-Corps are more complicated (you will need a lawyer), and C-Corps are VERY complicated (you will want at least 2 lawyers). The amount of legal fees and time spent creating the different corporations varies immensely. It's not as simple a comparison as just "tax code". If you are not sure what kind of corporation you want to set up, I highly recommend you spend a few hundred dollars and consult a lawyer for advice. The internet is a terrible place for legal advice.<p>Source: I own an LLC, and consulted a lawyer about C-Corps and S-Corps.
A Georgia LLC can choose to have some or all of its net income left in the company and taxed as C-Corp with the remainder distributed to shareholders as S-Corp. Its very flexible and there is no preset position. You look at your cash position come tax time and decide how best to deal with it.
One problem with the reasoning in this article: reinvested earnings usually don't sit on the company's balance sheet as cash -- they're reinvested into the business as wages, advertising, and other expenses, all of which reduce profit (but increase long-term enterprise value).<p>If you own a lot of proprietary IP, go with the C corp, otherwise if you're running an asset-light cash business where most of your revenue flows through to profit or pays short-term expenses (e.g consulting), a pass-through entity (LLC/S Corp) is probably better.
Author is likely incorrect about the C Corp retained earnings taxes, the tax owed for 100k of profit for Federal only would be more like $22,500 as the 15% rate is only for your first 50K of profit.<p>The corporate tax rate is very high and should really be thought of as 35% if you have meaningful profit.<p>You may also be able to defer profit if you're delivering service after you're paid for it (and you should be doing this), this keeps more money in the company without paying the taxes immediately. A far more important lesson.
Warning for anyone reading. There is a lot of wrong information in this thread as well as the OP. If you seek incorporation guidance, consult a professional attorney and CPA.
<i>Here’s the snag. If you are using a pass-through entity such as a LLC or S-Corp that money you are leaving in the company (retained earnings) is personally taxable to you in proportion to your ownership of the corporation.</i><p>LLCs and S Corps can be taxed like a corporation and not as a pass-through entity.
Why does any of this matter? If you need a particular corporate structure for an equity investment or other purposes, you form a new corporation that buys the assets of the old business, and life goes on.<p>A C Corp is absolutely nuts for anyone starting out, unless you just want to pay your taxes twice.
The article suggests, but doesn't explain why LLC / S-Corp is better if you are taking all the money out.<p>It feels to me that if you don't have to retain any money, then they both collapse to the same situation more or less. The only difference being C-Corp needing more expenses in accounting (and maybe legal) to just keep the books in order, but that is not a significant factor.
<i>This is not legal advice.<p>The article focuses on a very small tax issue that should not be determinative of business structure. The way a Start-up should decide to form a business generally should be as follows:<p>1. State - generally always choose the State the Founder is physically located. If you choose Delaware or another State you are not physically located, you must "qualify" your business to do business in every State you have a physical presence - failure to qualify may negate any protections offered by the business structure.<p>2. Structure -(Corp (S or C) vs LLC) This is determined on a two part analysis: First, I start with liability, CPAs typically only look at the tax issue, you want to ensure the Founder(s) will not be liable for business debts and the business can not be liable for Founder's personal debts. Example, I would always advise against a "single member" LLC because an LLC is considered a Partnership, thus Courts will not enforce Partnership protection where there are no Partners (ie, single member) and the LLC can be liable for Founder's personal debts - on the other hand a CPA will usually recommend single member LLCs because they are taxed like a sole proprietorship(make filing taxes really easy). Second, should be the tax issue, if multiple Founders I suggest LLC, especially when there are foreign Founders, if it is a single Founder then I suggest Corp. and S status if qualified.<p>3. Cost- This should never be determinative but taken into consideration. The cost of forming/qualifying Corp and LLC can vary greatly among the States. Additionally, compliance (annual reports, state taxes) among the States can vary as greatly as well as the cost of compliance and the penalties for failure to timely file can be very costly.<p></i><i></i>I know the word in SV is that Start-ups must be C-Corps incorporated in Delaware in order to receive funding. My thought is that if a Start-up is already incorporated/organized and has not received funding the Founders can easily: 1. "Domesticate" their business entity to Delaware, if an LLC perform a Conversion to a C-Corp., or 2. Dissolve and have the investors attorney's draft the new Delaware Articles of Incorporation.<p>As to the tax issue discussed I did not notice the article discuss that an LLC can be taxed as a C-Corp and if qualified elect S status. Also, playing the game of minimizing salary and maximizing distributions, while obviously beneficial because an owner only pays payroll and FICA on salary not on distribution, becomes a dangerous game that may result in the IRS knocking on the door. However, to the best of my knowledge the IRS has only ever gone after S-Corporations in such situations and have not set a precedent of going after LLCs.
Firstly, I am skeptical that the author uses the word 'thru' so much.<p>Secondly, if I were to take all the money personally, and then say, buy something useful for myself that my business could really use too, instead of retaining money on paper, does that not work?
S Corps are referred to as "Professional Corporations". Their intended purpose was for Doctors, Lawyers, Consultants etc. and other people looking for liability protection for services they provide. I believe in some states they even restrict the number of shareholders.<p>Take that for what it's worth.