Company Registration
The main types of companies include:
Sole Proprietorship
Suitable for independent contractors, consultants, or freelancers. No forms need to be submitted, and operations can commence. Tax reporting is done on the individual's Form 1040 Schedule C. This form of company setup is the simplest and easiest to dissolve. (For a single-member LLC, tax reporting is also done as a sole proprietor, using Schedule C).
General Partnership
Involves two or more individuals operating together.
Limited Liability Company (LLC)
A suitable option for small businesses, including foreign individuals. LLCs have no restrictions on ownership, and foreigners can be owners. An LLC can be member-managed or manager-managed, providing flexibility in management. Additionally, an LLC does not require hiring employees; a single person is sufficient.
For tax purposes, an LLC has three initial options:
Default as a pass-through entity, where income is treated as personal income on Form 1040 Schedule C.
Choose to be taxed as an S corporation.
Choose to be taxed as a C corporation.
C Corporation
By default, a corporation is a C corp unless it files Form 2553 with the IRS to elect S corp status. It's essential to note that the S corp or C corp designation is for federal taxes, and not all states recognize S corp status. For small and new companies, setting up an LLC is cost-effective, with relatively low operating costs. However, if the company's income or net profit is expected to be high, C corp might be a better choice, especially for tax advantages.
S Corporation
Limited to a maximum of 100 shareholders. S corps are restricted to U.S. citizens or resident aliens. Understanding residency for tax purposes can be ambiguous; for instance, someone on an H1B visa who has been in the U.S. for many years might be considered a resident alien for tax purposes.
Once the company name and type are chosen, the next steps involve filling out forms and paying registration fees on the state government website. Simultaneously, it is necessary to apply for an Employer Identification Number (EIN) from the Internal Revenue Service (IRS). The EIN applicant must provide a valid taxpayer identification number (SSN, ITIN, EIN).
After successfully registering the company, our accounting firm can assist with additional services, such as applying for business licenses, drafting operating agreements, payroll processing, financial accounting, and various corporate tax consulting services.
The accounting firm will now provide a brief overview of the tax differences between LLC and S Corporation.
Tax Differences between LLC and S Corporation
LLC Operation
Operations are straightforward.
Profits and losses pass through to shareholders and are reported along with each shareholder's individual income tax.
All income in an LLC is subject to payroll tax (employment tax), which includes Social Security (SSN) and Medicare tax, at a rate of 15.3%.
S Corporation Operation
More complex, requiring regular shareholder meetings and meeting minutes.
Profits and losses pass through to shareholders and are reported along with each shareholder's individual income tax.
Only the wages paid to employees are subject to payroll tax. Other than wages, the remaining profits distributed as dividends are not subject to payroll tax and are reported along with individual income tax.
If a company generates substantial profits, an S Corp may be advantageous in terms of taxes. However, it's important to note that the IRS requires S Corps to pay reasonable wages to employees. Therefore, withdrawing money from an S Corp as dividends instead of wages must be done cautiously to avoid issues with the IRS.
In summary, if a company is highly profitable, an S Corp may be more suitable as it allows for significant portions of profits to be treated as dividends, which are not subject to payroll tax, unlike an LLC where all income is subject to payroll tax.
Tax Differences between C Corporation and S Corporation
C Corporation
Files taxes independently as a separate legal entity, using Form 1120.
Initial tax rates are relatively low, such as a tax rate of 10-15% for net profits up to around $30,000.
C Corps can retain earnings within the company, making it suitable for reinvesting profits and growing the business.
S Corporation
Taxed similarly to an LLC, with profits and losses passing through to individual shareholders.
Limited to a maximum of 100 shareholders.
Only wages paid to employees are subject to payroll tax; profits distributed as dividends are not subject to payroll tax.
C Corporations may face double taxation issues, as profits are taxed at the corporate level and again when distributed to shareholders. However, C Corps offer advantages for reinvesting profits into the company. Planning for taxes is crucial for C Corps to minimize tax liabilities.