The decision of how to structure your business is one of the first, and most important, considerations a business must make. We have outlined the four corporate structures available to businesses.
C corporations, or C corps, are considered to be the business structure of choice for many businesses, particularly for those selling goods. Unlike sole proprietorships, C corps shield the personal assets of owners and shareholders from business liability. Essentially, they are treated as “persons” subject to their own tax structure and reporting requirements.
The corporation is responsible for paying all of the business’s expenses and costs, rather than its owners or shareholders and it is the only entity that can deduct them. The corporation pays tax on its net income or loss and distributes any profits to its shareholders in the form of dividends. Shareholders must pay taxes on their dividends, which creates a double tax. This tax can only be avoided if the business operates at a loss or profits are reinvested into the business. In addition, the owners and shareholders of C corps do not run the company’s day-to-day operations. That task is left to the corporation’s management team members, who are employees of the corporation.
Incorporating as a C corporation can be costly. In addition to legal fees, the corporation is responsible for paying state and federal filing fees and various licensing and other fees. In addition, C corps are required to:
- Select a board of directors, schedule regular board meeting and keep detailed minutes of these meetings
- Draft corporate bylaws, voted on by the board, which are the official rules for operating and managing the corporation
- File their articles of incorporation
Limited Liability Companies
Limited Liability Companies, or LLCs, are a hybrid alternative to C corporations because they combine elements of corporations, partnerships and sole proprietorships. LLCs need only one owner, but there are restrictions on the types of businesses that can operate as LLCs. Generally, businesses in regulated industries and some licensed businesses cannot become LLCs.
Like C corporations, LLCs protect the personal assets of their owners, also called members, from any legal or financial liabilities incurred by the business. LLCs usually are taxed as pass-through entities, which allows them to deduct 20 percent of qualified business income from their personal tax returns. The company, however, can elect to be taxed as a corporation, which may be a good option in certain situations.
Becoming an LLC is relatively simple. In most states, the only requirements are that the owners file an articles of organization with the Secretary or State or equivalent entity and pay a filing fee. State law varies, however, so it is important to check state law before you file.
Professional Corporations are very unique because all shareholders must be members of the same profession and be involved in the same business. Examples include medical practices, law firms and accounting firms.
As with other corporations, the shareholders have limited liability. Each shareholder, however, retains responsibility for his or her professional negligence or malpractice. Depending on state law, limited liability partnerships (LLPs) may be a better option for these businesses.
S Corporations are corporate entities that are similar to C corporations in that their shareholders have limited liability and the corporation has the same documentation and compliance obligations. S corps differ from C corps in these important ways:
- S corp status must be elected using Form 2553. This is the default status for C corporations
- S corps are taxed similarly to partnerships in that they are considered pass-through entities
- S corps may have up to 100 shareholders, all of whom must be U.S. citizens or residents