William A. Livingstone,CPA
The most common type of corporation in the U.S. is the C Corporation.
By forming a C Corporation, business owners create a separate legal structure that helps shield their personal assets from judgments against the company. C Corporations have a specific structure that includes shareholders, directors, and officers.
The C Corporation is a time-tested business formation. It has many advantages, including:
- Limited liability for directors, officers, shareholders, and employees
- Perpetual existence, even if the owner leaves the company
- Enhanced credibility among suppliers and lenders
- Unlimited growth potential through the sale of stock
- No limit on the number of shareholders, although 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, including tax-deductible business expenses
The C Corporation structure does have its drawbacks. For instance, a C Corporation's profits are taxed when earned and taxed again when distributed as shareholders' dividends, what's known as "double taxation." Shareholders in a C Corporation also can't deduct any corporate losses. To avoid these concerns, many small business owners choose to form an S Corporation instead.
S corporations share many of the same advantages as C Corporations, including;
- Limited liability for directors, officers, shareholders, and employees
- Perpetual existence, even if the owner leaves the company
- Enhanced credibility among suppliers and lenders
- Unlimited growth potential through the sale of stock . S corporations are limited to the number of shareholders and who can be a shareholder.
Corporations that meet certain requirements can elect an S Corporation tax status with the IRS. This federal tax status enables companies to "pass through" their taxable income or losses to owners/investors in the business, according to their ownership stake in the business.
By default, companies that do not specify a tax status with the IRS are considered to be C Corporations - which means that they will be taxed as a C Corporation. On the other hand, by electing S Corporation status, a corporation can eliminate the disadvantage of "double taxation" of corporate income and shareholder dividends associated with the C Corporation tax status.
General partnership (partnership)
An association of 2 or more people carrying on a business with the motive of earning a profit. A partnership is viewed as being one and the same as its owners. A partnership can be formed with little formality. In fact, if someone can establish you are in business with someone else then there is a general partnership.
Like a sole proprietorship, a partnership has only one level of taxation. A partnership is a tax-reporting entity, not a tax-paying entity. Profits pass through to the owners and are divided in accordance with what is specified in the partnership agreement. There are no restrictions on how profits are allocated among partners as long as there is economic reason, so there is latitude in allocating income according to which partners have the best tax rates.
Limited partnership
A Limited partnership (LP) is much like a general partnership, but with a few significant differences.
Management of a limited partnership rests with the "general partner," who also bears unlimited liability for the company's debt and obligations. A limited partnership allows for any number of "limited partners," whose liability is limited to the total amount of their investment in the company.
Limited partners are sometimes referred to as "silent partners" - in other words, they can make investments in the company but have no voting power or control over its day-to-day operations. They can be a valuable source of capital in this business structure.
Limited partnership is the entity of choice for many law, accounting and finance firms. It's also a popular among businesses that focus on time-restricted projects, such as real estate and film production companies.
Partnerships report their income and expenses on form 1065. Partners (or LLC members accepting the default tax treatment) each receive schedule K-1 which reorts their proportionate share of income (loss) and other items.
When looking at business types, many business owners choose to form a limited liability company (LLC) as a way to "wall off" their personal assets from the company's liabilities, offering protection for their personal assets in the event of a judgment against their business. For this reason, it's a better fit for many owners than a sole proprietorship or a general partnership.
A limited liability company (LLC) also has certain tax advantages. The default tax status for an LLC is partnership (sole proprietor if a single member) which means LLC's owners, known as "members," report their share of business profit and loss on their personal tax returns, similar to tax reporting for a general partnership. This is known as "pass-through" taxation. The members of an LLC can elect to be taxed as a C corporation in the LLC pays taxes and not the members. An LLC electing corporation tax status can then also elect S corporation tax treatment.
In short, the limited liability company business structure has many advantages, including:
- If not electing to be taxed as a corporation, pass-through taxes. There's no need to file a corporate tax return. Owners report their share of profit and loss on their individual tax returns.
- No residency requirement. Owners need not be U.S. citizens or permanent residents.
- Legal protection. Owners have limited liability for business debts and obligations.
- Enhanced credibility. Partners, suppliers and lenders may look more favorably on your business when you've formed an LLC.
The sole proprietorship is the most common form of business structure for small companies. It is viewed as being one and the same as its owner. This characteristic has the advantage of simplicity but also has the disadvantage of personal liability. A sole proprietorship has pass-through taxation. The business itself does not file a tax return; rather, the income and expenses pass through and are reported on Schedule C of the owner's personal tax return.