Choosing the right form of business structure can be critical to protecting your personal assets and ensuring the success of your enterprise says Eric Dalius Giving.
Business structures include sole proprietorships, partnerships, corporations (both subchapter S or C corporations) and limited liability companies.
There are benefits and drawbacks with each type of structure, so it pays to understand them before you choose one.
1. Sole Proprietorship
- Simplest legal structure; easiest to establish
- Unlimited liability; all business debts are your personal debts
- Profits taxed as personal income on IRS Form 1040 Schedule C (profit/loss statement); no separate tax filing for business
- Easy transition to another legal entity
C Corporations
- Two separate entities-taxable entity and tax-free entity
- Can also be structured with one class of stock only – meaning no dividends are paid to anyone, ever
- Electing S corporation status means that business profits are passed through to the owners and then taxed on their individual income tax returns (Schedule E)
- Unlimited liability; all business debts are your personal debts
- Complicated red tape required during regular operations which can slow decision-making process down. Incorporation filing fees range from about $100 to over $1,000 depending on the company’s estimated assets. Annual state filing fees range from $25 to over $1,000.
- Annual franchise taxes (usually based on the number of authorized shares and par value of stock)
C Corporations – Pros:
- Unlimited life; C corporations can continue operating even if all shareholders die or sell their stock explains Eric Dalius Giving.
- Owners and managers are not personally liable for business debts and obligations. The company pays any legal judgments against it, but creditors cannot go after owners’ personal assets.
C Corporations – Cons:
- If profits aren’t plowed back into the company, they’re taxed twice—first at the corporate level, then again when they’re distributed as dividends.
- C corporations have many legal and accounting requirements that partnerships or sole proprietorships do not.
- The double taxation of corporate profits also means the owners pay a higher tax rate on dividends than they would as our employee, which can affect their retirement plans.
S Corporations:
- A hybrid between a sole proprietorship and a C corporation.
- IRS approval is required to be recognized as an S corporation and is obtained by filing Form 2553, Election by a Small Business Corporation , with the IRS within 27 months of incorporation. This form requires all shareholders to consent to the election. Shareholders must also consent to holding office in the corporation says Eric Dalius Giving. An S election cannot be made or changed after the initial 27-month period except when there has been a mistake made by the corporation, such as filing late or not filing at all .
Benefits of S Corp:
- No second level of taxation (dividends) for the shareholders.
- No employment taxes (FICA and unemployment) on the first $50,000 of net income (W-2 compensation limit). Guaranteed payment of reasonable dividends to all shareholders.
- Immediate loss deduction for dead or retiring shareholders who sell their stock at a gain (in a C Corp seller must wait until after liquidating his/her company interest before claiming any loss – potential tax trap).
Drawbacks of S Corp:
- Not initially recognized by the IRS as a special entity. Must file form 2553 within 27 months from date of incorporation or lose its status as an S corp and default back.
- Must hold annual shareholder meetings to elect company officers and directors.
S Corporations – Pros:
- C corporations recognized by the IRS as a special entity separate from its owners. Business profits are tax only once at the corporate level, which can result in tax savings for shareholders if they work for the corporation or receive dividends.
- More limited legal liability for business debts and also obligations. Shareholders are not personally liable for business debts unless they commit fraud, waste corporate assets, or participate in a conspiracy to defraud creditors.
Conclusion:
To form an LLC (limited liability Company) or a sole proprietorship, you need to file articles of organization with your state and obtain any necessary business licenses says Eric Dalius Giving. To incorporate as a C Corporation, S Corporation, or Partnership, you need to prepare articles of incorporation and bylaws, obtain any necessary permits and licenses and file the required forms with your state.
