I strongly recommend starting your business entity as a C-Corp instead of an LLC
(disclaimer: this post is specific to businesses starting in the United States and I am not a tax lawyer)
This issue may be well-trod territory on this forum, and its indeed been covered by people who talk about startups, but I've also heard sentiments to the contrary. Mostly the idea is that is a bit easier to get going as an LLC starting from nothing, and operationally there's no real difference between the two for small companies. This is definitely true, and bootstrappers are sometimes told that, "the difference between the two matters more for VC-backed startups."
I started CoderPad as an LLC and converted to a C-Corp a couple years in (because it made issuing shares much easier). However, I've just run into a lesser-known reason that in my mind settles the issue entirely: the Qualified Small Business Stock Exemption. This post covers the topic in more depth, but essentially, if you hold stock in a small domestic C-Corp for five years, you gain a $10M exemption on the sale of those shares.
The upside is thus: if you ever sell your business, you can get a $10M writeoff on capital gains taxes, provided you've been operating for at least five years. If you live in California (effectively a 39% capital gains tax at the high end), this is about $4M in "free" money back.
Since I converted instead of starting as a C-Corp, I don't yet qualify for the QSBS exemption, which is a pity and essentially an unforced error on my part. You may not think you'll sell your business, but any business that does well is suitable for selling. You may as well prepare for success.
Was not the reason that I was expecting when I came into this thread. Thanks for the heads up, very useful
A great tip I hadn't seen before, but going C corp also means that every year you're in business, you're also paying tax on profits twice. First under the corporations filing, then again personally if you take the profits. Right?
In practice, no: your salary, paid to yourself from the corporation, is an expense on the corporations books and reduces its profits.
I am not an accountant, but I believe that you are correct. However, many small businesses do not operate at a (big) profit. For instance, I know a 40-person plumbing business where the owner pays himself on salary, and spends any "profits" on expenses and bonuses. Most businesses aren't hoarding cash.
Would this still apply to asset sales, or only if you are selling your stock in a company?
I believe it's stock sale only.
correct
Wow 39%. What were they thinking?
Interesting. We made an S-corp election after being a C-corp. I'm not an accountant, but I'd imagine that the annual tax savings of a profitable S-Corp or LLC might - for some businesses - outweigh the eventual tax savings of a sales event. I'd love to see some analysis of this.
I've been an S-Corp for many years and it's a great fit for service-type businesses like small agencies that generate cash flow but are not good candidates for eventually being sold.
Thanks for the advice, which state you recommend for a C-corp? Delaware? or is there one with lower taxes?
You pay taxes where you do business, not where you incorporate.
Delaware.
Since most of the IH audience are new entrepreneurs, what do you think about the idea of starting an umbrella LLC first, under which you are launching projects? If one of the projects gains serious traction, spin that off into a C-Corp with separate books? (I know you're not a tax lawyer haha, just wondering about this concept in theory.)
I actually just got my LLC article Friday for my umbrella company for this exact purpose, so I'm curious about this too.
There's no reason you can't just have a ccorp own all your projects, too, as far as I know. If you do t have an idea with traction you may not need any business entity at all.
Thanks!
Thank you for sharing! I'm getting ready to launch my product (www.tribefive.me for reference) and have been considering LLC versus C-Corp.
I plan to use Stripe Atlas and thy have some good guides to consider between the two structures...but I have not heard of this $10M write off before.
Thank you again for this valuable insight to consider.
Wow! thanks for sharing... What was the process of converting the LLC to C-corp like? Any advice on best ways to do that?
You should certainly use a lawyer for that, but there are a few standards methods of conversion: https://www.nolo.com/legal-encyclopedia/converting-llc-corporation-s-corporation.html