When starting a business, it is important for entrepreneurs to consider the best type of entity for their needs and ask “SHOULD I START A CORPORATION OR LIMITED LIABILITY COMPANY?” The answer may be neither. Although anyone can start a business without creating an entity, in most cases liability and tax considerations mean that creating an entity is the best way to run a business.
A C corporation (“C-Corp”) gets its name from Subchapter C of the Internal Revenue Code (“IRC”) – which is the part of the tax law that corporations will be taxed under (unless they make the S corporation election as described below). A C-Corp pays “double taxation” which means the corporation is taxed on gross profits before distributing any profits to the corporation’s shareholders in the form of dividends. The individual shareholders are then responsible for personal income taxes on the dividends they receive. Although double taxation seems to be an outcome a company would want to avoid, there are benefits for larger corporations to conduct business under this tax election. Other benefits of creating a C-Corp can be discussed with an attorney depending on the type of business and goals for its future.
An S corporation (“S-corp”) gets its name from Subchapter S of the IRC which provides corporations a “tax election” option — a choice on how they want to be taxed. Under Subchapter S, a company elects to pass all its profits to its shareholders directly, referred to as “pass through taxation.” This means that the funds are only taxed once. A S-corp has certain limitations that need to be considered when deciding what type of entity to establish that can cause organizers to prefer an LLC structure. These limitations include but are not limited to: 1) all shareholders in an S Corp must be US citizens, 2) there can be no more than 100 shareholders, and 3) the S-corp can only have one class of stock. If these limitations do not affect the entity owners, then an S-Corp may be the best election for smaller businesses.
The idea of limited liability is that creating an entity builds a barrier between a business owner’s company and personal assets. This means that if the company debts exceed the amount invested in the company, or a judgment is entered against a company, creditors cannot come after the personal home or other assets of the shareholders of members. It is important to note that this barrier can be torn down in the event shareholders or members co-mingle their personal funds or attach their personal assets to the company. The steps needed to preserve the limited liability barrier for an entity should be discussed with the entity’s attorney or CPA.