Federal and state laws allow individuals to choose from several business structures when forming a business. Each business structure offers advantages and disadvantages. Choosing the best business structure depends on the immediate and future needs of your business. Qualifications and requirements differ for each business structure. It is important for business owners to understand the features and tax implications of each before choosing a business structure.
A limited liability company (LLC) provides the personal liability of a corporation while offering the tax advantages of a partnership. An LLC protects owners from inheriting the liability of paying business debts, which means creditors cannot sue owners for money owed. Individuals, corporations and other LLCs can share in the ownership of an LLC. According to the Internal Revenue Service, an LLC is not recognized as a business structure for tax purposes, so it must file a tax return as a corporation, partnership or sole proprietorship. Small businesses with only a few owners benefit the most from forming an LLC. One disadvantage of an LLC its business life is not perpetual and owners can't issue stock in a public offering.
A sole proprietorship is a business structure with only one owner. Many independent contractors, such a freelance writers, bookkeepers, lawyers and plumbers, operate their companies as a sole proprietorship. It is the easiest business structure to establish. The owner of a sole proprietorship is not personally protected, and creditors may seek the owner’s personal assets as a way to pay outstanding debts. Sole proprietors must pay individual taxes by filing Form 1040, Schedule, as well as federal income, Medicare and Social Security taxes. Sole proprietors are required to register their business in most cities and counties.
An S Corp is one of the two types of corporations business owners may establish. In an S Corp, the profits or losses earned by the business are streamlined to the shareholders. This allows S Corps to avoid the double taxation that many C Corps experience. The IRS requires shareholders to file an individual tax return and pay federal income taxes on profits received from the S Corp. Only domestic companies can register as an S Corp. To qualify for an S Corp, a business cannot exceed 100 shareholders and can only possess one class of stock. Unlike a C Corp, an S Corp cannot offer its shares at a public offering, which means shareholders are private owners.
A C Corp is the type of business structure used by companies that issue stocks at a public offering. The shareholders of a C Corp vote to select the company’s board of directors. Similar to an S Corp and LLC, owners are not personally liable for business debts. An advantage of forming a C Corp is that tax laws allow the primary business owner to deduct its portion of the cost of employees’ health plans as a business expense. Another advantage is that the corporation's board decides how much of profits to pass on to shareholders and how much to keep in the business as retained earnings. There is no limit to the number of shareholders of a C Corp and the business enjoys the benefits of a perpetual life. The disadvantages of forming a C Corp are double taxation, a large amount paperwork and high fees required to register the business.
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