Cannabis Entity Selection
In times when you need to make a cannabis entity selection, you can find three main business structures that differ in your rights and obligations. In the cannabis business, you can consider an LLC, C corporation (“C-corp”), or S corporation (“S-corp”). All three structures give you certain advantages that we discuss further.
What Is LLC?
Limited liability company (LLC) is a separate and distinct legal cannabis entity selection. With LLC, you can get a tax identification number, and you can also open a bank account and do the business under your name. Limited liability companies combine the characteristics of a corporation and the characteristics of a partnership or sole proprietorship. It is a specific type of private limited company that uses corporate tax rules instead of being treated as a partnership. In the cannabis business, LLCs offer much flexibility and easier formation that a corporation.
What Are the Advantages of LLCs?
If you decide to form an LLC, you will find the process much simpler than with other entities. The procedure is less “formal” than opening other kinds of business, and the main advantages are:
- Simplified tax reporting
- Easy formation
- Reduced formality process
- Protection from creditors
- More flexibility
Owners of an LLC have flexible tax reporting options, which means that you can choose how the entity will be taxed. You can pay taxes on your shares of the business income while using personal tax returns. This is a form of taxation of a partnership entity. On the other hand, you can choose to be taxed as a corporation, which separates tax obligations from the owners. Both situations can be beneficial, and your choice depends on the tax structure you plan to have as part of your business.
LLC also offers a highly flexible management structure when comparing to a corporation. At the same time, you have flexible tax reporting options in all 50 states, including the District of Columbia. With LLC, you also have other positive sides that are related to limited personal liability. This kind of limited liability is connected to business debts and court judgments against the business. Your personal assets as a business owner are shielded in the case of debt or court judgment. That is why you have the right to protect your personal finances when you decide to form a cannabis entity selection in the form of an LLC.
What Is Corporation (Inc)?
Corporations can take numerous forms. The most popular form is an S-corporation (s-corp) that is more like an LLC in the matter of taxation. In this case, the taxes “pass through” to individual business owners. An S-corp is the entity that was most used in forms of small businesses before the LLC became a legal form of business. An S-corp is considered a “pass-through” entity because the business itself is not taxed. All the income is reported on the personal tax returns of the owners.
What is the Difference Between S-corp and C-corp?
With the S-corp, the owners pay personal income tax on profits, and the business must not pay corporate income tax, which is not the case with C-corp where the business must pay corporate income tax. At the same time, all the income or loss is passed through to owners each year with the S-corp. In the form of S-corp, you cannot have more than 100 shareholders when comparing to C-corp where the number of shareholders is unlimited. Shareholders must be U.S. citizens or resident aliens when you have an S-corp.
Businesses taxed as C corporations are different in the taxable incomes that are taxed at the corporate level. In the situation when the dividends are distributed, the income is taxed at the individual level. C-corps are not pass-through entities by default.
In terms of raising funds through successive entity financing, a C-corp might be a better choice than any other entity. Raising funds from institutional investors is also better with C-corps. Corporations have much better options when it comes to choosing the types of investors the business can approach. In the same manner, the corporations are issuing better equity incentives to employees which brings many advantages in financing through equity investments.
C corporation is the best option in raising funds, but the taxation regulations must be considered with much attention when choosing this form of entity. There are many cases of “double taxation” when a corporation is subject to income tax at the entity level. As we know, the corporate tax rate is historically high, and this kind of double taxation could be a huge financial risk for many business owners.
The Bottom Line
As we can see, cannabis entity selection in both forms of LLC and corporation has positive and negative sides. When you decide which business entity to form, you should consider all the aspects of your business. LLCs offer flexible tax reporting options that give you many different possibilities to pay taxes in your state. With LLCs, you have the option to protect your personal finances as taxation usually affects the business entity, not the owners. At the same time, the procedure of forming the entity is much faster and simpler than the formation of a corporate entity.
On the other hand, there are two forms of corporations that have their advantages. With an S-corp, the business doesn’t pay the corporate income tax, and personal assets can be protected. At the same time, you have a tax-favorable characterization of income and heightened credibility.
With a C-corp, you can raise funds more easily and have unlimited numbers of shareholders. These entities are not pass-through entities, which means that the owners are excluded from paying taxes individually. Only the corporation is subject to income tax.
All the forms of legal entities are part of cannabis businesses in the U.S., and the business owners decide to form each entity depending on the company management, business plan, and financial situation. You can have multiple benefits from each entity, but you should also consider the downsides of each business structure. That is why consulting your cannabis attorney can give you a huge advantage in the cannabis business. With the right cannabis attorney, you can consider all the options and find the cannabis entity selection that is the most suitable for you.
Thomas Howard has been in business for years and can help yours navigate towards more profitable waters.
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Our cannabis business attorneys are also business owners. They can help you structure your business or help protect it from overly burdensome regulations.