You’ve made the decision to start or purchase a business. Now, it’s time to determine what type of business entity will provide you with the best benefits. Each type has its own advantages and disadvantages so you may want to connect with an accountant or attorney before deciding. Here’s a review of all the major types of business entities available for your business startup.
Limited Liability Company (LLC)
A limited liability company (LLC) is similar to a sole proprietorship (business owned and run by a single individual), except when it comes to liability issues. A sole proprietorship requires that the business owner be responsible for all business liability and debts. With an LLC, the business owner is not personally responsible for the business liability.
LLCs can be run by a single person (taxed like a sole proprietorship) or multiple people (taxed like a partnership). LLCs are great for freelancers or individuals in the retail or service industries that deal directly with others. LLCs are not good for anyone who needs investors since many investors either don’t like these types of businesses or can’t invest because of tax-exempt partners. Plus, not everyone can form LLCs, particularly those in the trust, banking and insurance industries. Certain states like California have further restrictions on who can form an LLC. Contact your state government to determine if they have restrictions or additional fees for LLCs.
Standard Corporation (C-Corp)
A Standard Corporation, or C-Corp, is owned by shareholders – not a single owner or partnership. Shareholders take on liability, but personal liability is limited to how much they invest in the company. Shareholders are responsible for the business decisions and policies, and are required to elect a board of directors. C-Corps are subject to double taxation: The overall company tax income is taxed at the standard corporate tax rate. Then shareholders also pay taxes on distributed profits or dividends.
The major advantage of a C-Corp is that the actual owners of the company have very limited liability, meaning they can’t be sued individually for business debts or misconduct. C-Corps work well for people who don’t plan on distributing all of the company’s profits. You can split up the business income: part taxable to the business and part taxable to the owner. This will put you in a lower tax bracket, meaning you won’t pay as much tax. C-Corps are good for medium to large business owners.
An S-Corp is a C-Corp with a special tax status. You have to follow all the same requirements as a C-Corp, but the S-Corp is not subject to double-taxation. Business profits and losses are passed onto the shareholders, and they report this on their individual tax returns. Shareholders must pay the tax. As a business owner, you are responsible for ensuring that your shareholders receive a “reasonable” salary.
S-Corps are really designed for small businesses that have less than 100 shareholders (either U.S. citizens or resident aliens). This type of business can only have one class of stock, and it may be subject to additional state taxes. You do, however, still limit your overall liability, protect your assets and establish credibility if you’re just starting out.
Both C-Corp and S-Corp business entities limit your IRS audit exposure.
Always do your homework before deciding on a business entity. Review the tax implications and the benefits/risks of each business entity. Also, look at the state requirements placed on each entity. If you are still unsure how you should proceed, seek out professional assistance.