If you are bootstrapping, does it make sense to start as a Delware LLC to keep your tax liability at a minimum and then switch to Delware C Corp when you raise funding?
Disclaimer: I'm not a lawyer or accountant, and you really should consult one of them about your specific scenario.
Short answer: it's complicated, but probably C Corp. For the reason that if there's any chance you're going to take angel investment or give stock to employees, you almost need a C Corp. In fact, the lack of a standard C Corp just creates complications with investors and employees that puts you at risk. Keep it simple.
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C Corporations are almost necessary if you are planning on taking investment. They are not as tax-efficient as LLCs because they're taxed twice (once at the corporate level, and another time at the personal income level / capital gains level depending on whether $ is paid out via salary or dividend.) However, they come with the benefit of having different classes of stock (usually required for investors / employee stock options).
LLCs are pass-through entities. They reduce taxes for shareholders by basically eliminating payroll / capital gains taxes.
If you have an LLC and want to take investment, it is relatively straightforward to convert to a C Corp if its early enough in the company's lifespan.
On the other hand, converting from a C Corp to an LLC is a pain (you have to create a separate LLC and have it buy the assets of the C Corp, which creates a taxable event).
An s-election is a good option to reduce tax-liability of a corporation. It grants pass-through status. However, to be eligible, you have to file in the first 75 days of the year, you can only have common stock, and all shareholders have to be US Citizens (no LLCs, etc).
Thanks for the detailed answer. "If you have an LLC and want to take investment, it is relatively straightforward to convert to a C Corp if its early enough in the company's lifespan." Do you mean company's lifespan or the cap table structure? I found this article http://www.nolo.com/legal-encyclopedia/converting-llc-corpor.... It seems to mention only that the conversion should happen before the investment.
My intent is to get our saas product out and start charging through our website. So, I was thinking that forming an LLC is the cheapest way to get there. Spending several thousand dollars to form a C-corp seems too much at this point. http://www.quora.com/How-much-does-it-cost-to-set-up-a-C-cor...
I think it is worth the money, if you can afford it, to just do it right from the beginning (Delaware C Corp). Significantly reduces stress. If you need to raise money, you can do it and there wont be any issue with your incorporation documents during due diligence. And sometimes fixing things later is more costly than just paying the ~$5K upfront.
Please do not use RocketLawyer or something similar. They are super cheap, but they only create a shell C Corp. I made that mistake which luckily wasn't costly to fix.
My understanding is that if you form a C Corp, then you have to pay corporation tax and then your personal income tax. With LLC you can avoid that. Probably not an issue if you are paying yourself the minimum salary.
You pay corporate tax on profits. You're not going to have any recognizable, taxable profits if you're bootstrapping a company that will take VC at some point.
If you are bootstrapping then it is quite likely that you will make a profit [1]. The reason why is that you need to build up capital in the business to provide a buffer for anything going wrong or to take advantage of new opportunities. Trying to run a bootstrapped company on the knife edge of break even is not easy.
1. This is assuming that you have not been lent the capital required to the company.
The company pays taxes on its income, but the salaries are generally deductible from the income that the company is taxed on (as are a whole bunch of other expenses).
You do have a minimum state tax regardless of revenue or profit, but corporate income tax is only on profit. Therefore double taxation does not matter until you are profitable. In addition, you can "carryover" losses from previous years to profitable years in order to reduce your tax burden. In other words, if you lose $10K in year one and have a profit of $10K in year two then you have $0 taxes in year two. The paperwork is complicated for "carryover" so please consult an accountant.
Short answer: it's complicated, but probably C Corp. For the reason that if there's any chance you're going to take angel investment or give stock to employees, you almost need a C Corp. In fact, the lack of a standard C Corp just creates complications with investors and employees that puts you at risk. Keep it simple.
*
C Corporations are almost necessary if you are planning on taking investment. They are not as tax-efficient as LLCs because they're taxed twice (once at the corporate level, and another time at the personal income level / capital gains level depending on whether $ is paid out via salary or dividend.) However, they come with the benefit of having different classes of stock (usually required for investors / employee stock options).
LLCs are pass-through entities. They reduce taxes for shareholders by basically eliminating payroll / capital gains taxes.
If you have an LLC and want to take investment, it is relatively straightforward to convert to a C Corp if its early enough in the company's lifespan.
On the other hand, converting from a C Corp to an LLC is a pain (you have to create a separate LLC and have it buy the assets of the C Corp, which creates a taxable event).
An s-election is a good option to reduce tax-liability of a corporation. It grants pass-through status. However, to be eligible, you have to file in the first 75 days of the year, you can only have common stock, and all shareholders have to be US Citizens (no LLCs, etc).