One of the most important things when starting a business is to understand what type of legal entity you should choose - because - let's face it, you do not want to be operating as a sole proprietor for long.
There are so many variables in deciding the best entity selection for your business, which includes
- Forecasted revenues and profit for the next year, five years, etc;
- How many owners you will be working with;
- What type of investment funding you are looking for
- What is your overall growth and exit strategy.
Depending on these factors, your entity selection could be very different. However, this post is focused on providing some insight on operating as an LLC. This is not legal advise, I recommend talking with a CPA and lawyer to make this type of decision.
What is an LLC?
The IRS defines as an LLC as a legal entity that "may be classified for federal income tax purposes as a partnership, corporation, or an entity disregarded as separate from its owner."
Different LLC elections
First, If you decide to form an LLC, you will need to select which type of entity you will elect as.
- Partnership- If you have more than one member in your LLC, you will be formed as a partnership. The profits will be passed down to each of the partners.
- Disregarded Entity- If you are the sole owner/single member of the LLC you will be considered a disregarded entity, if you do not elect otherwise. his means that all the income and expenses will be reported on the owner's 1040, and the owner will be responsible for paying self-employment tax on these profits.
- Corporation- If you are a one man/woman show or you have multiple owners in your LLC, you can elect as a corporation (either an S corp or a C corp). If you choose to file your LLC as a corporation you will need to file an income tax return. Here's where it gets a bit more complicated:
- C corporation: the entity is taxed on its taxable income (what your company made for that year) and distributions (any payments to members if you choose to do so) to the members are includible in the members' gross income. This is where the "double taxation" comes into place.
- S corporation: the corporation is generally not subject to any income tax and the income, deductions, gains, losses, are “pass through” to the members.
There are several benefits of choosing an LLC as your legal entity for your business. The biggest advantages are (1) limited liability to all members (good asset protection) all while (2) not paying double taxation (assuming you don't elect the C corporation).
Plus, if you're looking to have investors, LLC's don't have a restriction on the number of members, unlike S Corps, and can accept foreign investors. And, if you're planning to grow and not positive on how that might match your legal entity structure, you can always convert your LLC into a corporation (it's much harder to go from a corporation to an LLC).
However, with 280e (if you are along the cannabis supply chain you are exposed to 280e in the US), and LLC might not be your best option. This is mostly due to your tax basis changing, the liability flowing to the owners and the company, and a few more things (shameless plug - check out Cannabis Accounting 101 Course).
Does my role in the industry impact my legal entity election?
It's a combination of your role, your growth (and exit) strategy, your assets, the number of members/owners, and your projected revenues that determine the best legal entity selection and legal entity structure. Once you've assessed all of these things with a lawyer and an accountant, you can definitely make the appropriate legal entity selection.