If you want to form a company, it’s vital to choose the right type of corporate structure for your organization’s needs. Known as a “business entity type,” your choice has permanent consequences for tax classification, personal liability, rules, regulations and more. That shouldn’t put you off though — we’ll give you the right information so you can make the best decision for your business.
Different Types of Corporate Structures
Limited Liability Company (LLC)
The LLC is one of the most popular types of business entities. It’s ideally suited for smaller organizations and startups, for several reasons:
- LLCs are fast and easy to setup.
- LLCs have a simple business structure.
- Forming an LLC is generally inexpensive.
- Running an LLC is easier than running a C Corp or S Corp.
- There are fewer rules, regulations and legal compliance issues for LLCs.
- LLCs are formed and regulated on a state level.
The cost and policies governing an LLC do vary from state to state. Check out our LLC State Information resource for additional info on your state.
LLC Limited Liability Protection
Like C Corps and S Corps, LLCs provide their owners with limited liability protection. This means the business assets are owned separately by the LLC, not by the owners. Any liability the business has (e.g. monies owed, equipment, depreciation, lawsuits, etc.) are purely the liability of the business, and do not (generally) have any impact on the individual owner’s personal assets.
LLC Taxes and Tax Returns
An LLC does not pay federal income tax itself. Instead, any net profit or loss is “passed through” to the personal tax returns of the owners or members. It is then taxed as personal income by the IRS. In this sense, taxation of an LLC is very similar to taxation of a sole-proprietorship or partnership.
Types of Tax an LLC is Liable For
It’s important to note that an LLC will be liable for certain types of tax, for example:
- Payroll tax on salaries paid to employees (but not to members or owners — they will pay self-employment tax on their personal tax returns).
- Sales tax on goods purchased by and for the business.
- Property taxes on owned business property.
- In certain cases, other types of tax or tariffs may need to be paid by an LLC.
- Generally, these taxes can be subtracted as business expenses and do not flow through to individual owner’s tax returns.
Subchapter or Small Business Corporation (S Corporation or S Corp)
The S Corporation, or S Corp, is a business entity that was created and enacted into law by Congress in 1958. It was created to encourage small and family business creation, while eliminating the double taxation that conventional corporations (C Corps) had to pay. Key factors for S Corps include:
- S Corps are formed and regulated on a state level.
- The liability of the S Corp and the personal liability of the owners and investors are separate.
- The liability of the owners and investors in an S Corp is limited only to the value of their investment.
- The owners of a corporation are not personally liable for business debts, claims, or other liabilities.
- There are some more legalities, rules, and compliance for an S Corp than an LLC.
- An S Corp has a slightly more complex corporate structure.
- S Corps are limited to having 100 shareholders.
- Running an S Corp is simpler and easier than running a C Corp.
S Corporation Taxes and Tax Returns
Unlike traditional C Corporations, the S Corporation does not need to pay corporate income tax. The S Corporation is a separate tax designation recognized by the IRS. Similar to the LLC, the net profit or loss generated by an S Corporation will flow through to the personal income tax returns of the shareholders and owners, and be subject to tax there.
As with LLCs, an S Corp will have to pay certain other types of taxes like payroll, property and sales tax on business purchases.
Forming an LLC but Paying Tax as an S Corp
When you create an LLC, you may have the option to choose to be treated as an S Corp for taxation purposes. This takes advantage of both business types, as follows:
- The rules and regulations for running an LLC are less onerous than running an S Corp.
- There may be tax advantages to being taxed as an S Corp, specifically around owners and members taking money out of the business.
- You can choose to pay yourself a “reasonable” salary and deduct monies above that as share dividend income. That additional income would not be subject to self-employment tax, although it would still be subject to personal income tax.
If you're interested in how to save additional money on taxes by filing your business as an S Corporation, check out our S Corporation Tax Calculator.
The C Corporation
A C Corp, also known as a C Corporation, is a type of business entity that is formed and regulated on a state level. It is created by filing “Articles of Incorporation” with the secretary of state within the state of incorporation. It is the most formal type of company and a corporate structure. The policies and cost of creating a C Corp vary from state to state. Factors affecting whether you would want to create a C Corp include:
- A C Corp has limited liability, so the investors and owners of a C Corp are not generally liable for business debts and other liabilities.
- Ownership of a C Corp is determined by who owns stock in the company.
- A C Corporation must issue stock.
- A C Corporation must hold an Annual General Meeting.
- The ownership of a C Corp can be fluid and transferred, depending on who holds stock at a particular moment in time.
- Stocks in a C Corp can be bought and sold on a public stock market if the C Corp holds an “Initial Public Offering (IPO)” where it makes it stocks available to the public.
- A C Corp is required to have a board of directors.
- A C Corp can raise more finances by issuing stock.
- A C Corp is required to meet numerous rules and regulations.
- Money earned by a C Corp may be subject to “double taxation.”
How Taxes Work In A C Corp
Unlike the the Limited Liability Company and the S Corporation, a corporation is required to file a corporate tax return and pay corporation taxes on any profits. When those taxes are paid to shareholders as dividends, they will also be subjected to taxation on that individual’s tax return. This is known as “double taxation.”
C-Corporation Tax Rates
C-Corporation tax rates are as follows:
Up to $50,000 — 15%
$50,000 - $75,000 — 25%
$75,000 - $100,000 — 34%
$100,000 - $335,000 — 39%
$335,000 - $10,000,000 — 34%
$10,000,000 - $15,000,000 — 35%
$15,000,000 - $18,333,333 — 38%
More than $18,333,333 — 35%
The Nonprofit Corporation
A Nonprofit Corporation is a type of corporation that donates any revenues generated to achieve a specific goal that is of public benefit. Nonprofit corporations are allowed to create profits, however those profits must be used to preserve the existence and expansion of the corporation.
In the United States, a nonprofit corporation is formed by filing articles of incorporation in the state in which it will operate. Incorporating the nonprofit creates a legal entity and enables the organization to be treated as a corporation by law, granting it the same rights and privileges afforded to for-profit corporations.
How Taxes Work In A Nonprofit
If classified correctly, nonprofits are exempt from federal, sales and property taxes. They do need to pay payroll taxes, and can be taxed if they make money from activities not related to their main purpose. To be recognized as a nonprofit by the IRS the corporation must file and obtain the appropriate classification. The majority of nonprofits must file form 501c3 with the IRS in order to receive the desired tax treatment.
A Note on Sole Proprietorships and Partnerships
Before closing, a word on sole-proprietorships and partnerships: although these may not be “formal” business entities, some people may choose to complete work as a sole proprietor or partner. In these cases, there’s generally no separate business entity — the business and the proprietor (or partnership) are effectively one and the same. This means all income, expenses and other financial matters would be reported on an individual’s personal tax return, and they’d pay tax accordingly. It also means there’s no separation for areas like personal liability.
We always recommend setting up a formal business entity — it keeps everything neater, removes personal liability for your business, and may have several tax advantages. Incorporate your business today using Incfile's three easy steps to online business formation.