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In a previous article we discussed the non-corporate forms of company organization. This post will cover the three most widely used legal entities in business, the LLC, C-Corporation and S-Corporation.
LLC
Most new businesses will need to form a legal entity to protect them against personal liability. If there is no corporate protection someone could sue the business (aka You) and take everything. The LLC is one of these business entities. The LLC, or Limited Liability Company, is an increasingly popular form of legal entity. It’s a hybrid legal structure that provides the protection features of a corporation with the tax efficiencies and operational flexibility of a partnership.
The “owners” of an LLC are referred to as “members.” Depending on the state, the members can consist of a single individual (one owner), two or more individuals, corporations, other LLCs, and even other entities. It has fewer restrictions than C-Corporations in addition to less paperwork. Who doesn’t want less paperwork?! The only real disadvantage to an LLC is that the entity is only in force for a finite period of time. An ‘end date’ is listed on the ‘Articles of Organization’ that are filed in the governing state.
LLCs are not taxed as a separate business entity. Instead, all profits and losses are “passed through” the business to each member of the LLC. The LLC members report profits and losses on their personal tax returns, just like the owners of an S-Corporation or partnership.
Even though the LLC has become the most popular form of legal entity, check with your attorney about using it in your state. Some states do not permit LLCs for certain types of businesses.
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C-Corporation
If a business is referred to as a ‘Corporation’ it is generally assumed to be a C-Corporation. A Corporation is also an independent legal entity. This means that the corporation itself, not the shareholders who manage it, is legally liable for the actions and debts incurred by the business. All corporations start out as C-Corporations and either remain that way or are elected to become S-Corporations. We’ll talk more about those later. C-Corporations are generally not the choice for someone starting a small business because of the additional paperwork and tax implications.
C-Corporations are more complex than other business types. They have costly administrative fees, complex tax rules and expanded legal requirements. Because of these issues, C-Corporations are generally suggested for established, larger companies with many employees. For those that need it, C-Corporations offer the ability to sell ownership shares in the business through stock offerings. “Going public” through an initial public offering (IPO) is a major selling point in attracting investment capital and high quality employees.
When you form a corporation, you create a separate tax-paying entity. Regular corporations are called “C-Corporations” because Subchapter C of Chapter 1 of the Internal Revenue Code. This is where you find the tax rules governing corporations.
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Clik here to view.S-Corporation
An S-Corporation is a corporation that has received the Subchapter S designation from the IRS. First, set up your business as a C-Corporation in the state where it’s headquartered. Then file a Form 2553 with the IRS to declare yourself a sub-chapter ‘S’ Corporation. According to the IRS, S-Corporations are “considered by law to be a unique entity, separate and apart from those who own it.” This limits the liability for which an owner/manager (aka YOU) is responsible.
Currently, most small businesses in the US are set up as S-Corporations. Until the LLC was developed a few years ago the S-Corporation was one of the most popular business entities. An S-Corporation or S Corp is a different type of corporation created through an IRS tax filing. Your corporation can avoid double taxation (once for the corporation and again for the shareholders) by filing with the IRS to be treated as an S-Corporation. The S-Corporation only pays taxes to the IRS through the private returns of its officers. The Corporation itself pays no tax even though it does need to file a return with the IRS. This tax advantage is the main reason that the S-Corp became so popular in the US.