Choosing an entity in practice
A decision table by goal — raise VC, bootstrap, consult, side project, real estate — and why Northwind is a Delaware C corporation.
Start from what you want the company to do, not from the tax rate. The table is a starting point for the conversation with a lawyer and a CPA, not a substitute for it.
Northwind's choice
Delaware C corporation
- Good at
- What investors buy.
- ISOs and QSBS.
- Losses carry forward.
- Watch for
- Double tax on distributions.
- Franchise tax and two states' filings.
- Best for
- Raising venture capital or granting options.
LLC
- Good at
- One layer of tax.
- Losses pass through.
- Can elect S or C status later.
- Watch for
- Converting before a round.
- Self-employment tax for active members.
- Best for
- Bootstrapped businesses, real estate, holding companies.
S corporation (election)
- Good at
- One layer of tax.
- No self-employment tax on profit above the salary.
- Watch for
- Payroll and a reasonable salary.
- No preferred stock or fund investors.
- Best for
- Profitable owner-operators with US individual owners.
Step 1: Decide
Choose the entity and the state of formation, with a lawyer if you will raise money.
Step 2: Form it
File the certificate of incorporation or formation, and appoint a registered agent.
Step 3: Get the numbers
Get the EIN, then open a bank account in the company's name — never mix it with your own.
Step 4: Issue the equity
Issue founder stock or record members' capital; file any 83(b) elections within 30 days.
Step 5: Register and elect
Register in the state where you operate, and file any S or check-the-box election on time.
Raising money: Delaware C corporation. Not raising: an LLC, with an S election once the profit pays for payroll.
Next, keeping it in good standing: the Compliance & tax track. Raising money and the cap table: the Cap tables & raising track. Setting up the rest of the back office: the entity and its numbers and separating business and personal money.
Where this lesson's rules come from
The sources behind this lesson's requirements, by kind. Anything marked as a convention is ours, not the rule-maker's.
- Federal statute
- 26 U.S.C. §1361(b)(1), (c)(4) (opens in a new tab)Small business corporation: no more than 100 shareholders, eligible shareholders only, one class of stockFree to read
- 26 U.S.C. §1202(c)(1), (d)(1), (i)(1) (opens in a new tab)Qualified small business stock is stock in a C corporation — and converted property starts the clock at conversionFree to read
- 26 U.S.C. §199A(a), (i), as amended by Pub. L. 119-21 §70105 (opens in a new tab)The qualified business income deduction — 20%, made permanent, with a $400 minimumFree to read
- Federal agency guidance
- SBA, Choose a business structure (opens in a new tab)Choose a business structure — the SBA's overview of the optionsFree to read
- SBA, Choose a business structure — Sole proprietorship, Corporation (opens in a new tab)Personal liability without an entity, and why corporations raise money more easilyFree to read
The words this lesson teaches
Each links to its glossary definition, which also names the authority behind it and the components that render it.
- C corporationA corporation taxed as a taxpayer in its own right: it files Form 1120 and pays 21% of its taxable income, and its shareholders are taxed again on what it pays them as dividends. Every corporation is a C corporation unless it elects S status
- Limited liability companyA state-law entity whose owners (members) are shielded from its debts like shareholders. Federal tax has no LLC category: by default it is a partnership with two or more members and disregarded with one, and it is a C or S corporation only if it elects
- S corporationA domestic corporation, or an LLC eligible to be treated as one, that has elected on Form 2553 to pass its income, losses, deductions and credits through to its shareholders. No more than 100 shareholders, all of them individuals other than nonresident aliens, estates, or certain trusts and exempt organizations, and one class of stock. Files Form 1120-S
- Sole proprietorshipA business one individual owns without forming an entity. Its profit is reported on the owner's Schedule C with self-employment tax on Schedule SE, and the owner is personally liable for its debts
- 83(b) electionAn election, filed with the IRS within 30 days of receiving restricted stock, to be taxed on its value at grant rather than as it vests — at a founder's purchase price, usually no tax at all, and the capital gain holding period starts at once
- ComminglingRunning company and personal money through the same account or card, so the books can no longer show whose a transaction was. The fix is a separate business account and a recorded entry — a reimbursement, a loan from the founder or a contribution — for every crossing
In the founder glossary
This lesson’s ideas, explained for the founder running the company. Each has an entry in the founder glossary.
See also
- First-year compliance calendar for a Delaware C-corpDelaware franchise tax, 1099s, the federal return, payroll filings, state annual reports and sales tax: the deadlines a young C-corp misses most, by month.
- How to account for SAFEs on your balance sheetA SAFE is cash today and shares later. Why it usually sits with liabilities, how the cap and discount set conversion, and what to book at the priced round.
- Qualified small business stockStock in a US C corporation, issued directly by the company while its gross assets were under a limit, can let holders exclude some or all of the gain on sale from federal income tax.
- SAFEA simple agreement for future equity. An investor pays now, and the SAFE converts into shares at your next priced round, usually at a valuation cap, a discount, or both. It carries no interest and no maturity date.
- Form 1120The federal income tax return for a C corporation. It's due on the 15th day of the fourth month after year end, so April 15 for a calendar-year company; Form 7004 extends the filing, not the payment, by six months.
- Delaware franchise taxAn annual tax, filed with an annual report, that every Delaware stock corporation owes by March 1, whether or not it made money.