Types Of Corporations
When a small business owner decides they want to incorporate, they often struggle to decide what type of incorporation to choose. While it can all be pretty overwhelming in the beginning, we hope to lay out the advantages and disadvantages of starting an LLC or a corporation, whether or not to classify it as an S Corp or C Corp, and give you a better idea of which one would be best for your business.
Business goals aren't one size fits all and neither is incorporating. When deciding which kind of corporation fits your business strategy, consider some of the different benefits that each kind offers. And take a deeper dive with the comparison.
"Incorporating a business is defined as the legal separation of a business entity from its owner. This new business 'person' is completely independent, meaning that even if something happens or changes take place with owners or administrators, the business will keep running and functioning as normal and without having to also change."
To determine which business entity will serve your new business best you need to start process of choosing between a sole proprietorship, a general partnership, a limited partnership, a limited liability partnership, a c corporation, an s corporation, and a limited liability company (LLC) involves much more than one would at first think. IQTAXX Las Vegas professionals are ready to help you make the right decision.
Limited Liability Company
Forming a limited liability company protects your personal assets by keeping them separate from your business assets, and it provides the greatest flexibility available when it comes to taxation and business structure.
An LLC is the most common choice for small businesses with a single proprietor or a small number of members, as it offers the protections of incorporation without the same requirements necessary for larger, multi-shareholder companies.
S corporations offer specialized taxation that limits the company's liability. When you form an S corporation, the company itself isn't taxed. Instead, profits and losses are tallied and taxed after being distributed to shareholders.
For this reason, an S corporation is most often chosen by companies incorporating with multiple shareholders, and is considered a good alternative to legal business partnership because it provides tax benefits without the overhead and complexity.
In C corporations profits are taxed at the business level before being distributed to shareholders, but the main feature of this type of incorporation is that it offers certain advantages that some companies require.
Specifically, a C corporation is the only option available for US companies choosing to work with foreign investors. Forming a C corporation also allows you more flexibility with shareholder involvement by making it possible to create multiple classes of stock.
Advantages of a C Corporation
- Limited liability. This applies to directors, officers, shareholders, and employees.
- Perpetual existence. Even if the owner leaves the company.
- Enhanced credibility. Gain respect among suppliers and lenders.
- Unlimited growth potential. The sky's the limit thanks to the sale of stock.
- No shareholders limit. However, once the company has $10 million in assets and 500 shareholders, it is required to register with the SEC under the Securities Exchange Act of 1934.
- Certain tax advantages. Enjoy tax-deductible business expenses.
Disadvantages of a C Corporation
- Double taxation. It's inevitable as revenue is taxed at the company level and again as shareholder dividends.
- Expensive to start. There are a lot of fees that come with filing the Articles of Incorporation. And corporations pay fees to the state in which they operate.
- Regulations and formalities. C corps experience more government oversight than other companies due to complex tax rules and the protection provided to owners from being responsible for debts, lawsuits, and other financial obligations.
- No deduction of corporate losses. Unlike an s corporation (s corp), shareholders can't deduct losses on their personal tax returns.
C Corporation vs. S Corporation
Both c and s corps offer limited liability protection. Both require Articles of Incorporation to be filed. And both comprise shareholders, directors, and officers. There are lots of similarities, but they differ in the complex realm of taxation and corporate ownership.
As we mentioned above, c corps are subject to double taxation while s corps are pass-through tax entities, allowing them to avoid being taxed at the corporate level and again on shareholders' personal income taxes.
When it comes to corporate ownership, c corps have no restriction on ownership, which goes back to our point about them having unlimited growth potential. But S corps don't have that luxury as they're restricted to no more than 100 shareholders. Also, s corps cannot be owned by a c corp, other s corps, LLCs, partnerships, or many trusts. But a c corp has no limits on who or what can be a shareholder.
Taxation of LLCs, S Corps, and C Corps
While the business structures are similar in some ways, the way each one is taxed is vastly different. Firstly, when it comes to taxation, a corporation can decide whether it wants to be an S corporation (S corp) or a C corporation (C corp); however, an LLC can also choose to be taxed as an S corp, C corp, or as an LLC. What are the differences and advantages to each one? Let's take a look.
When a business is taxed as an LLC, the owner reports business income and losses on his or her individual tax return. For this reason, LLCs are called "pass-through entities." The business itself is not taxed on its profit, but rather it passes through to the owner. The advantage to this is that it makes taxes a lot easier to report. The disadvantage is that the owner has to pay the self-employment tax, which requires sending in quarterly estimated tax payments. Another disadvantage is that it's harder to separate the owner from the business.
S corps are similar to LLCs in that they are also considered pass-through entities. The owner can often claim losses from his or her business as deductions on his or her individual tax return, but does not have to pay self-employment tax. The downside to S corps are found more in their business structure—they are limited to no more than 100 shareholders (who must be American citizens), and they cannot be owned by another LLC, S corp, or C corp. For this reason, many business owners decide to structure their business as an LLC, but file taxes as an S corp.
C corps, in contrast, are taxed as a separate entity from the owners. This separation means that there is a little more protection for the owner because he or she is only required to pay taxes on their share of the profit. However, it often means the business owner is taxed twice—once on the corporate level and then again on his or her individual tax return—which can prove to be costly for a small business owner. Also, C corp business owners cannot claim business losses on their individual tax return.