By The Jacobson Firm, P.C.
While there are many potentially lucrative benefits to forming your own business, without proper planning there are just as many potential downfalls. Here, we will discuss the basic legal implications that you should consider before creating your own company. The two most popular limited liability business entities in New York are Corporations and Limited Liability Companies (L.L.C.s). This article is not meant to give legal advice; any slight variation in a situation can create a substantially different result or decision, and should be accorded separate attention from an attorney and/or an accountant.
A key difference between the two types of New York business entities lies in how the businesses are taxed. The IRS designates a corporation as either an “S” or “C”. “C” corporations permit the taxation of income twice (double-taxation), as the corporation is initially taxed approximately up to 35% of its net income for that year, and those shareholders are then taxed again (at their ordinary personal income tax rates) for any personal income they receive from the corporation, generally in the form of dividends. Alternatively, in an “S” corporation, the corporation passes the income (without taxing itself) directly to the shareholders, who are then taxed according to their respective percentage of ownership. Consequently, income is only taxed once as the corporation itself is not responsible for paying taxes on its net income. “S” corporations can only have a maximum of one hundred shareholders, all of whom must be U.S. citizens or residents. “C” corporations, on the other hand, have no limit on the number or type of shareholders that the corporation can have.
When a business entity incorporates, it has the option of choosing between Inc. (incorporated), Corp. (corporation), or Ltd. (limited) as the suffix to its name. It is important to note that the corporation’s name must include one of these suffixes, so as to inform the public of the type of liability that the corporation carries (the type of liability might affect an individual or company’s decision of whether or not to go into business with the corporation). Upon its original formation, a corporation automatically exists as a “C” corporation. If the shareholders unanimously agree to have the corporation taxed as an “S” corporation, you must file with the I.R.S. and state in a timely manner. Failure to do so may lead you to lose the right to elect the “S” tax designation for that tax year. If a corporation elects “S” status, the filing must be made by the fifteenth day of the third month after the corporation has assets, issues stock or begins to operate (whichever occurs first).
“S” Corporations and L.L.C.s are similar in many ways. Both entities provide protection to their owners’ personal assets against the business entity’s debts and liabilities. Neither “S” corporations nor L.L.C.s are taxed at the entity level, as both permit all profits and losses of the business to flow through to the personal tax returns of their owners.
While “S” corporations and L.L.C.s are quite similar, there are differences. “S” corporations are subject to restrictive ownership rules, whereas L.L.C.s are subject to more lenient rules. Shareholders of an “S” corporation must be U.S. citizens or residents, while foreign membership is permitted in an L.L.C. Other corporate entities such as outside corporations, partnerships, and L.L.C.s may not own stock in an “S” corporation, whereas they are permitted to own interests in an L.L.C. The “S” corporation has a formalized and structured management system which requires accurate book and record keeping (ie. minutes of board and shareholder meetings, shareholder records, etc). The L.L.C., on the other hand, has a more informal and flexible management structure that does not have to follow these set statutory guidelines.
Furthermore, “S” corporations have an inflexible allocation of profits and losses based solely on the number of shares an individual possesses in the corporation, as well as structured voting rights based on stock ownership. Conversely, an L.L.C. may have a more flexible allocation of profits and losses to its members (whether or not said flexibility will exist can be decided through an agreement between members). An L.L.C. also provides members with flexible voting rights, the flexibility of which can be determined by an agreement among members (shareholder agreement).
There are also advantages to choosing a corporation over an L.L.C. L.L.C.s have publication requirements, while corporations do not. In New York, an L.L.C. must publish a notice of its formation and must file affidavits of publication within approximately 120 days after the formation; this can be enormously costly. An L.L.C. is required to provide a copy of the Articles of Organization to be published in the county where the principal office of the L.L.C. is located. The County Clerk selects the newspapers that are chosen for publication. One of the newspapers chosen must be daily and the other may be weekly. Thus, in New York, due to its higher filing fees and publication requirements, forming an L.L.C. in New York State is more expensive than forming a corporation. Advertising costs could be a thousand dollars and may be more depending on which county they conduct business in. Before making the decision on how to set up your business, you must consider the many factors that will ultimately affect your company, including: ancillary issues regarding copyrights, taxes, business laws and trademarks, among many others. While the formation of your business can be relatively easy, this process should be taken on with the support and knowledge of legal counsel.
This article is not intended as legal advice, as an attorney and/or an accountant specializing in the field should be consulted.
(c) 2013, 2015 The Jacobson Firm, P.C.