Starting a U.S. Company Makes Sense but the Entity Type is Important
What is the Best U.S. Company Structure for a Non-Resident? - With the largest economy in the world, the United States of America offers some of the best possible business opportunities. Founded on the principles of the free market, the U.S. is rich in business opportunity. In this article we will look at the various U.S. company entity types that are best suited to non-resident business owners, alongside their structural and taxation benefits.
Limited Liability Companies (LLC's)
The most common option when setting up a U.S. company is what’s known as a ‘Limited Liability Company’. An LLC lets you take advantage of the benefits of both the corporation and partnership business structures while allowing for minimal bureaucratic overhead.
LLCs protect you from personal liability in most instances, your personal assets — like your vehicle, house, and savings accounts — won't be at risk in case your LLC faces bankruptcy or lawsuits.
Profits and losses can get passed through to your personal income without facing corporate taxes. However, members of an LLC are considered self-employed and must pay self-employment tax contributions towards Medicare and Social Security.
LLCs can have a limited life in many states. When a member joins or leaves an LLC, some states may require the LLC to be dissolved and re-formed with new membership — unless there's already an agreement in place within the LLC for buying, selling, and transferring ownership.
LLCs can be a good choice for medium - or higher-risk businesses, owners with significant personal assets they want to be protected, and owners who want to pay a lower tax rate than they would with a corporation.
Advantages of an LLC
For those thinking of starting an LLC, here are six of the main LLC benefits.
1. Limited Personal Liability
If your business is a sole proprietorship or a partnership, you and your business are legally the same “person.” Your business debts are also your personal debts. And if your business partner or employee is accused of negligence, your personal assets might be at risk.
An LLC limits this personal liability because an LLC is legally separate from its owners. LLCs are responsible for their own debts and obligations, and although you can lose the money you have invested in the company, personal assets such as your home and bank account can’t be used to collect on business debts. Your personal assets are also protected if an employee, business partner or the business itself is sued for negligence.
2. Less Paperwork
Corporations also offer limited liability, but they have to observe certain requirements that may not be well suited to a small, informally run business. For instance, corporations typically must hold annual shareholder meetings, make annual reports and pay annual fees to the state. They also tend to have substantial recordkeeping requirements.
In contrast, LLCs don’t have to hold annual meetings and Usually are not required to keep extensive records. In many states, LLCs do not need to file annual reports.
3. Tax Advantages of an LLC
LLCs get the best of all worlds when it comes to taxation. LLCs don’t have their own federal tax classification, but can adopt the tax status of sole proprietorships, partnerships, S corporations or C corporations.
The Internal Revenue Service automatically classifies LLCs as either partnerships or sole proprietorships, depending on whether they have one owner or more than one owner. This means that LLCs can always take advantage of “pass-through” taxation in which the LLC does not pay any LLC taxes or corporate taxes.
Instead, the LLC’s income and expenses pass through to the owners’ personal tax returns, and the owners pay personal income tax on any profits.
In contrast, traditional C corporations are taxed twice on distributions to shareholders: once at the corporate level and once at the individual level. S corporations avoid double taxation and receive pass-through tax treatment, but not all corporations are eligible.
4. Ownership Flexibility
S corporations enjoy pass-through taxation, but they have several ownership restrictions. For example, they can’t have more than 100 shareholders, can’t include foreign shareholders and can’t have shareholders that are corporations. LLCs provide pass-through taxation without any restrictions on the number and type of owners they can have.
5. Management Flexibility
Corporations have a fixed management structure that consists of a board of directors that oversees company policies and officers who run the day-to-day business. Owners, also known as shareholders, must meet every year to elect directors and conduct other company business.
LLCs don’t have to Use this formal structure, and an LLC’s owners have more choices about the way they run the business and make decisions.
6. Flexible Profit Distributions
LLCs have flexibility in the way they distribute profits to their owners, and they aren’t required to distribute them equally or according to ownership percentages. For example, two people may have equal interests in an LLC, but they may agree that one of them will receive a greater share of the profits because he or she contributed more money or labor in the business’s startup phase.
Corporations, on the other hand, must distribute profits to shareholders according to the number and types of shares they hold.
An LLC’s simple and adaptable business structure is perfect for many small businesses. While both corporations and LLCs offer their owners limited personal liability, owners of an LLC can also take advantage of LLC tax benefits, management flexibility and minimal recordkeeping and reporting requirements.
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Limited Liability Partnership's (LLP's)
Partnerships are the simplest structure for two or more people to own a business together outside of a multi-member LLC. There are two common kinds of partnerships: limited partnerships (LP) and limited liability partnerships (LLP).
Limited partnerships have only one general partner with unlimited liability, and all other partners have limited liability. The partners with limited liability also tend to have limited control over the company, which is documented in a partnership agreement.
Profits are passed through to personal tax returns, and the general partner — the partner without limited liability — must also pay self-employment taxes.
Limited liability partnerships are similar to limited partnerships, but give limited liability to every owner. An LLP protects each partner from debts against the partnership, they won't be responsible for the actions of other partners.
Partnerships can be a good choice for businesses with multiple owners, professional groups (like attorneys), and groups who want to test their business idea before forming a more formal business.
LLP or LLC? Each Offers Liability Protection
Both an LLC and an LLP help business owner limit their personal liability. In both types of businesses, owners may lose the money they've invested in the company, but their personal assets aren't at risk if the business or a co-owner is sued. LLC members and LLP partners always remain personally responsible for their own wrongful actions.
Limitations on LLP vs. LLC Ownership
Many states limit LLP ownership to certain professionals such as lawyers, doctors, and accountants. In these states, other types of business owners can't form an LLP, and business professionals may not be able to form an LLC. Find about your state's LLP restrictions before you consider forming one.
In addition, an LLP is a type of partnership, and by definition it must have more than one partner. An LLC can have just one member. There is no upper limit on the number of owners that LLCs and LLPs may have. LLCs can have corporations, trusts, or other LLCs as owners, but this may not be true for LLPs in your state.
LLC Taxes vs. LLP Taxes
An LLP is taxed like a general partnership. The partnership reports business income and expenses on a partnership tax return, and each partner in turn reports a share of the profits or losses on his or her personal return. This is known as “pass through" taxation because there are no corporate taxes or LLP taxes. The profits “pass through" to partners who pay tax at their individual income tax rates.
By default, an LLC with more than one LLC member is also taxed like a general partnership, and a single member LLC is taxed as a sole proprietorship. However, all LLCs have the flexibility to choose corporate taxation instead. This tax flexibility is one of the advantages of an LLC over an LLP.
LLC versus LLP: Management and Profits
An LLP operates like a general partnership, but with liability protection for its partners. This means that, by default, the partners share equally in decision-making and management, and each partner has the power to bind the company to contracts. Partners also equally share profits and losses. Depending on your state, some or all of these rules may be modified by a partnership agreement. LLPs can be well-suited to professional partnerships where the partners tend to operate independently.
LLCs can be managed by the members, or they can be managed by a group of managers, with the nonmenacing members acting in an investor role. An LLC operating agreement can specify a management structure, contributions of members, responsibilities of members, how decisions will be made, and how profits and losses will be distributed. Many small, informally-run businesses choose LLCs because of this flexibility in structure and management.
Forming an LLC vs. Forming an LLP
To form either an LLC or an LLP, you must file organizational documents with your state agency responsible for business filings. Forms and instructions are typically available on the agency website, and filings must be accompanied by a filing fee. In addition, all LLCs should have an operating agreement and all LLPs should have a partnership agreement to spell out the rights and responsibilities of the owners.
In many states, LLP formation paperwork requires more detailed and specific information than LLC formation documents. LLPs also may face greater restrictions on their ability to do business in states other than the one where they were formed. LLCs can generally do business in other states, so long as they file foreign business registration documents in those states.
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A corporation, sometimes called a C corp, is a legal entity that's separate from its owners. Corporations can make a profit, be taxed, and can be held legally liable.
Corporations offer the strongest protection to its owners from personal liability, but the cost to form a corporation is higher than other structures. Corporations also require more extensive record-keeping, operational processes, and reporting.
Unlike sole proprietors, partnerships, and LLCs, corporations pay income tax on their profits. In some cases, corporate profits are taxed twice — first, when the company makes a profit, and again when dividends are paid to shareholders on their personal tax returns.
Corporations have a completely independent life separate from its shareholders. If a shareholder leaves the company or sells his or her shares, the C corp can continue doing business relatively undisturbed.
Corporations have an advantage when it comes to raising capital because they can raise funds through the sale of stock, which can also be a benefit in attracting employees. Typically, in the U.S., any outside investment would require a c-corp as the company structure. This is especially true in the tech industry.
Corporations can be a good choice for medium - or higher-risk businesses, businesses that need to raise capital, and businesses that plan to "go public" or eventually be sold.
Here is a Quick List of C Corporation Advantages:
• They can have an unlimited amount of shareholders, from anywhere in the world.
• For Nevada and Wyoming corporations, officers and directors can reside anywhere in the world. This can be a boon for foreign investors.
• They can have several different classes of shares.
• They have the widest range of deductions and expenses allowed by the IRS.
• They are the most widely recognized business entity in the world, and are the premier entity for going public.
• In Nevada and Wyoming, nominee (or stand-in) officers and directors can be utilized, adding extra levels of privacy.
• If your operating a tech company or startup with plans to seek venture capital in the U.S. then a c corp is the only option that outside investors will feel comfortable investing in.
Tax Advantages of C Corporations
A C Corporation has the widest range of deductions and expenses allowed by the IRS, especially in the area of employee fringe benefits. A C Corporation can set up medical reimbursement and other employee benefits, and deduct the costs of running these programs, including all premiums paid. The employees, including you as the owner/shareholder, will also not pay taxes on the value of those benefits.
This is not the case in a flow-through entity, such as an S Corporation, LLC or LP. In each of those cases the entity may write off the costs of the benefits, but any employee/shareholder who owns more than 2% of the entity will pay taxes on the value of their benefits received. So, if having the maximum deductions and all of the employee fringe benefits on a tax-free basis is important to you, a C-Corp may be your entity choice.
Tax Disadvantages - Double Taxation Issues
The most often-cited disadvantage of Using a C-Corp is the “double-taxation” issue. Double-taxation happens when a C-Corp has a profit left over at the end of the year and wants to distribute it to the shareholders as a dividend.
The C-Corp has already paid taxes on that profit, but once it distributes the profit to its shareholders, those shareholders will have to declare the dividends they receive as income on their personal tax returns, and pay taxes again, at their own personal rates.
There are many things you can do to avoid the double-taxation scenario:
• Structure the C-Corp so that there are no profits left over – Use all of the write-offs and deductions allowed by the IRS to reduce the C-Corp’s net income.
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*Disclaimer*: Yondaa, Inc. is neither a law firm nor an accounting firm and, even in cases where the author is an attorney, or a tax professional, nothing in this article constitutes legal or tax advice. This article provides general commentary on, and analysis of, the subject addressed. We strongly advise that you consult an attorney or tax professional to receive legal or tax guidance tailored to your specific circumstances. Any action taken or not taken based on this article is at your own risk. If an article cites or provides a link to third-party sources or websites, Yondaa, Inc. is not responsible for and makes no representations regarding such source’s content or accuracy. Opinions expressed in this article do not necessarily reflect those of Yondaa, Inc.