Both Limited liability companies (LLC) and C Corporations will provide limited liability for founders. When deciding between an LLC and a C Corporation, consider how you intend to structure the ownership and leadership of your business, your goals, and potential tax obligations.
When forming an LLC, owners create an Operating Agreement, a contract specifying how the business will be run and how costs and profits will be shared. As long as all parties agree to the terms, the actual structure of your LLC can be at your discretion.
Operating an LLC moves liability for debts and obligations of the business from the entrepreneurs into the entity itself. LLCs and corporations will provide limited liability for their shareholders.
The choice can be driven by many factors like tax obligations, corporate governance, the need to raise venture capital or issue stock to employees, or other enterprise objectives.
Concerning tax issues, LLCs are "pass-through" entities. Pass-through taxation allows LLC's members to pay personal income taxes on the income of the business.
On the other hand, a corporation is an independent entity for tax purposes. Corporations generally pay corporate taxes on their own profits, and their shareholders pay personal income on the capital distributed to them.
Shareholders are taxed separately if the company distributes dividends to them, or if it pays them a salary, in the case of employee shareholders. If the shareholders are not US residents and don’t have physical presence in the US, they are normally not liable for paying US personal income taxes.
Important: Generally, If the members or shareholders of a US entity are foreigners who don’t meet the “substantial presence test”, and the company doesn’t have any “US-connected income”, it has no tax liabilities in the US. The term “US-connected income” generally means income generated in the US, and applies to businesses that have physical presence of the business in the United States and operate in the US through a “permanent establishment” (e.g. an office or other fixed place of business) or have “dependant agents” (e.g. full-time employees, or contractors and companies that work almost exclusively for the company) that do something essential to grow your business in the US.
The US uses the Substantial Presence Test as a way for international residents to assess whether they qualify for certain tax requirements based on the physical duration of stay within the US. From the guidelines provided by the IRS (www.irs.gov), here are the terms you must meet for the calendar year for tax purposes:
- 31 days during the current year, and
- 183 days during the 3-year period that includes the current year and the 2 years immediately before that, counting:
- All the days you were present in the current year, and
- 1/3 of the days you were present in the first year before the current year, and
- 1/6 of the days you were present in the second year before the current year.
If a foreign person meets the substantial presence test, they will be considered a US resident for tax purposes. In this case, a foreign person may become liable for paying US personal income taxes.
You were physically present in the US on 120 days in each of the years 2012, 2013, and 2014. To determine if you meet the substantial presence test for 2014, count the full 120 days of presence in 2014, 40 days in 2013 (1/3 of 120), and 20 days in 2012 (1/6 of 120). Since the total for the 3-year period is 180 days, you are not considered a resident under the substantial presence test for 2014.
However if you are over the 183 days for the substantial presence test, you may be required to pay US taxes. To receive an expert consultation, please speak with one of the tax attorneys or CPA firms within the Firstbase.io Network to assess your specific situation and obtain accurate information around the required tax liabilities.
Some basic distinctions and examples of both types of legal entities are as follows:
- LLC is an excellent choice for eCommerce stores and small online projects.
- LLCs offer limited liability for founders, simple structure, and ease of management.
- LLCs don’t have shares, so you won’t be able to issue stock or go public — but many pretty huge companies are LLCs (Basecamp, Mailchimp), so you can still achieve a lot with this structure.
- C Corporations are ideal for businesses seeking to raise money from angel investors or VC firms.
- Corporations also offer limited liability for founders and a flexible structure.
- The ownership of the company is expressed in shares of stock, and you can use these shares to raise capital and issue employee options.
When deciding between an LLC and a C Corporation, consider how you intend to structure the ownership and leadership of your business, your fundraising and hiring goals. A core component of the Firstbase.io Network is access to law firms, tax attorneys, and CPAs who can support you as you grow your business regardless of the type of entity you launch with Firstbase.io.
It is possible to convert an LLC to a C Corp in the future (even changing the state). Businesses may decide to change their structure to accept outside funding or allocate shares to employees.