I currently just finished building my web startup (a social networking website). I am planning to eventually monetizing the site some time later down the line. For now I am bootstrapping, and I am considering seed funding. What would be the best option for me when it comes to incorporating my company? What state should I incorporate my company? Out of the three options, which one would i benefit the most from: LLC, C or S corp?
First, you are not incorporating a website. You incorporate a business. If you are seeking equity funding you have huge issues that only an experienced business lawyer can address for you. The entity de jour is the limited liability company because you have more options. But, that does not mean that it is always the best choice. An LLC can elect to be treated as if it were a corporation by the IRS and then it can even elect to be taxed as a Sub-S corporation. But it is still legally an LLC. As to what state law to use, the answer would require a great deal more information. For Texans whose business in primarily derived from the internet, either Delaware or Texas would be high on the list of choices.
Business Formation Issues
One of the first things you need to do when starting a new business venture is decide on the type of business entity you wish to be. A business can be run as: 1) a sole proprietorship, 2) a partnership, 3) a corporation or 4) a limited liability company. Choosing which type of entity to use in your business venture generally comes down to two issues; limited liability, and taxation.
Corporations and Limited Liability Companies (LLC) offer limited liability to their shareholders while sole proprietorships and partnerships do not. In the interest of brevity, I will not further explain sole proprietorships and partnerships other than to say that if you are in business online today either one of these are clearly not a good idea. This will become clearer as we explain the many benefits of limited liability with regard to corporations and the LLCs.
There are many misconceptions concerning the concept of limited liability. The premise of limited liability relates only to the investor’s financial responsibility for the debts of the entity In a limited liability entity, once the shareholder has made their investment they have no further obligation with respect to the entity’s debts. However, a shareholder, particularly a shareholder who is active in the business operations, is still liable for the criminal and tortuous (i.e. negligence, fraud, sexual harassment, etc.) acts they might commit in connection with the business.
While a business conducted as a sole proprietorship or a partnership does not provide limited financial liability to the owners, these entities have an advantage over the corporation when the tax man cometh. For the purpose of calculating taxable profit, corporations are treated as a separate entity and charged taxes on the profit they generate. with the added liability of being assessed at a higher rate than the rate used for individuals or partnerships (which are taxed are the individual’s rate.) Adding further insult to injury, distributions to shareholders are taxed to the recipient, which in effect taxes the profits of the corporation twice; once as a corporation, and once again when distribution and doled out as income to shareholders.
As you can see, when deciding between running your business as a corporation or as a sole proprietorship or partnership, you need to balance the need for limited financial liability against the prospect of higher tax rates and double taxation. But there is a work around that many smaller corporations use to avoid the double taxation issue.
In the 1980’s the first Limited Liability Companies were formed under new laws in Wyoming and Florida when the IRS agreed to tax these limited liability entities as partnerships. The states wrote very simple regulations for these LLC’s and by the late 1990’s almost every state had adopted LLC legislation. By providing partnership taxation treatment along with limited liability for shareholders with greatly simplified regulations, the LLC has become the most popular business entity in the U.S. today.
Other considerations in choosing your entity:
1) Accountants generally charge far less for preparing an LLC return than a corporate return.
2) Pass through taxation of the LLC at individual rates.
3) Flexible Management and Ownership Structure.
4) Less Formalities and Paperwork.
Andrew M. Jaffe
Attorney at Law
Practice Limited to E-Commerce and Internet Law
The question you are asking is nontrivial and requires far more information to answer than your brief synopsis provides. Having said that, corporations, as a general rule, provide the surest means of raising outside capital in that investors are usually more comfortable with the well established rules and terminology involved. A general overview of business forms: Sole Proprietorships and Partnerships are fine if your legal liability is low. that is, your business is unlikely to cause injury to anyone. Your legal liability is unlimited. That is, if your business is sued for any reason, any judgment for the plaintiff will put your personal assets at risk, not just business assets. LLCs: very flexible entities which can be taxed either as partnerships or corporations at the federal level. Some states (Texas and California for instance) subject LLCs to “franchise taxes” in addition to a federal income tax. LLCs, though extremely flexible, are relative newcomers with a less well established track record for raising funds, in the minds of many. S-Corporations may provide some tax savings because profits from an S-Corp are "flow-through" and not subject to dual taxation (corporate tax and individual tax on dividends). However, owner-employees should take a “reasonable salary” which is subject to employment tax before they take a distribution. Also, S-corporations are significantly more complicated from a tax and legal standpoint than LLCs. This will likely cost you more with your attorney and CPA. S-corps are easier to operate than C-corps with less onerous paperwork overheads; however they have limitations in things like the number and kinds of investors permitted, and the kinds of stocks permitted. C-Corporations are taxed on their income (as opposed to other structures which simply pass the income along to the owner(s), who are then taxed on it). Owners will also be taxed on the dividends the corporation pays them. In other words, the corporation is taxed once on its income, and then the shareholders are taxed upon any dividends they receive. Like S-corporations, C-corporations are more complicated than sole proprietorships, partnerships, or LLCs. The choice of a C corp versus S corp is another question requiring more information than you've provided. The state you form your business in will depend on where you expect to do the most business, what kind of business you intend to engage in, where you live, etc. Most states have seen the light and support the various business entities fairly well; however, your specific details will drive your decision.
Contact an attorney and let him assess your particulars.
As mentioned by other attorneys, you're incorporating a business, not a website. Whether you want to choose an LLC, C, or S corp is a fairly detailed question that needs to take into consideration your future plans with the company. For example, what level of control do you want to maintain over the company in the future? Are you comfortable with giving away part of the ownership in the future in exchange for the services of a competent employee? Would you be afraid of not being able to get rid of that employee if the relationship goes sour? These are but a few of many considerations.
The differences between an LLC, C, and S corporation are numerous at the tax level. A single member LLC's earnings flow through to your 1040, so there is no need to file a separate form with your taxes. In contrast, both an S corporation and C corporation have separate filing requirements. So if simplicity is your goal, then go with the LLC. That being said, never let the tax tail wag the dog.
There are a lot of other questions that an attorney would need to know in order to answer your question more completely.
Best of luck,
This is a very big question and there are many considerations. As my colleague noted and which I agree we will have more questions than answers at this point.
You should take the time to discuss with an attorney and explore the options in light of your specific circumstances.
I will link you to some very general but helpful info on entity formation below.
So, you write once again from Sugar Land and still do not have an attorney. \
Remember the 3 little pigs. You should, I think, want to be the third pig because believe me there will be wolves trying to blow your website down. Right now you are the first little piggy and had better hope there are no big bad wolves looking to ear your website for dinner.
You have not "finished" building your website if you have no attorney, no trademark application, no copyright registration and no clearance work done.
You don't incorporate a website, you incorporate the business that runs the website. You are such an utter novice to be here seeking this advice on Avvo. We have told you before this site is not a recipe for how to do complex legal work without an attorney.
A few months back we had a fellow "Maxi" [atty-client privilege prevents disclosing real name] from Argentina who tried the same dumb scheme of repeatedly asking here on Avvo and claiming to be too poor to hire an attorney and even emailing several of us to try to pinch us for free work, with little to no success. He was also a first little piggy and he has disappeared [apparently went bust], to the surprise of none of us attorneys.
You are repeating a well-worn path to oblivion. Better choose the path less traveled and get an attorney as that will likely make all the difference.
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