When starting your own business, you will have to decide if you should incorporate or not. Then you have to choose between the different types of entities depending on what your business type and structure needs. If you already own a business you should always revisit at some point to see if you should make a change. There are many
advantages and disadvantages to each business type, but we will focus on just a few here to help you decide.
One major advantage of incorporating, is that it limits what is referred to as your “legal liability”. What this means is that you will not be responsible personally for any liability or debt that you incur as a corporation. The responsibility is limited to the assets of the business, while your personal assets are usually not at risk. Several businesses operate as sole proprietors and the issue of liability may not be as important to them depending on their size and business type. In some instances, insurance may cover the extent of their liability.
There is a fee to incorporate any type of business and the tax impact on each type of business varies. Most business owners who decide to incorporate typically choose between corporate formations such as a C Corporation, an S Corporation or an LLC. There are many advantages and disadvantages etc. to each business type. As such, there are numerous factors to consider when making that choice as . Here are a just few to help kick-start your decision making.
C Corporations: This is the most commonly known and most traditional entity type. It is primarily used by large businesses. While this type of entity is flexible in ownership structure and benefits, its main disadvantage is that of double taxation. Meaning that essentially you are taxed twice. Once as a corporation and then again as an individual. This occurs because the corporation first pays tax on whatever profit it makes and then the individual shareholders pay tax on whatever dividends they recieve.
S Corporations and LLCs: S-Corporations are more modern than the traditional corporation and they are referred to as “pass-through entities. The term “pass-through” entity means that these business types are not taxed at the corporation level. Instead, the taxes are “passed through” to the owners. As far as taxes are concerned, an LLC is flexible as the owners can elect to be taxed as a Sole Proprietorship, a Partnership, a Corporation or an S- Corporation. While there are advantages and disadvantages to being taxed as all of the above, most business owners like the idea of being taxes as an S-Corporation. One of the main reasons is because unlike the corporation, there is no double taxation on the S-Corp. With an Scorp, the profits and losses are “passed-through” to the shareholders, i.e. they are reported and taxed only on the owners’ individual income tax returns. The business return is just informational.
As far as ownership structure there are a few limitations to the S-Corporation and LLC.
- S-Corp – No more than 100 shareholders and all shareholders must be U.S. citizens or U.S, permanent residents. No foreign owners are allowed.
- LLC’s (registered with a State) are more flexible with ownership rules than the regular S-Corporation is and the number of shareholders allowed is unlimited. This is yet another one of many reasons why they are a popular choice of businesses.
If you already own a business or you are just getting started, entity choice selection is extremely important. Established businesses should reconsider their entity choice during the lifetime of their business. Many have been known to change from one type to another. As they grow and evolve, businesses often need to do so in order to maximize the advantages that would work best for them depending on their level of growth and thier changing business needs.
If you need assistance with entity choice, business formation and filing. Please contact us. We will be glad to help ensure your selection fits your business and financial goals.
Natasha Dornbush, CPA