Which type of corporation should you make? C, S, or LLC?

Jan 8, 2007 by

Although publicly traded companies are all C Corporations, it is useful to know the difference between sole proprietorships C Corporations, S Corporations, and Limited Liability Corporations (LLCs) if you are considering investing in a private company or are considering founding a corporation (incorporating) yourself.

What is a corporation?

A corporation is a “fictional person”. It is assigned a Tax ID Number (TIN), and must file taxes returns. (Real people, unlike corporations, have Social Security Numbers, which also act as TINs.) As a fictional person, a corporation can take out loans, sign contracts, and can have a credit rating that is independent of that of its owners. In some cases, it can also utilize various laws to offer its employees benefits (health insurance, pensions, etc.) using pre-tax income. Corporations come in many flavors, including sole proprietorships, C Corporations, S Corporations, and Limited Liability Corporations (LLCs).

Sole Proprietorships
Perhaps the simplest kind of corporation is a sole proprietorship; a business run by one person. While maintaining a sole proprietorship requires few tax forms beyond personal income tax returns, it also offers few benefits. The owner of a sole proprietorship absorbs full legal liability for the debts of the company. If the company defaults, the owner is liable. The corporation’s income is taxed at the owner’s tax rate.

Limited Liability Corporations (LLCs)
Like sole proprietorships, LLCs are not required to have a Board of Directors. However, unlike sole proprietorships, the liability of the owner(s) is limited to the amount they have invested in the LLC. If an LLC goes bankrupt, no liens will be placed against the owner’s personal assets. An LLC can be taxed as a corporation or as a partnership depending on how it has been organized.

S Corporations
S Corporations are corporations designed to be held by a 100 or less shareholders. Thus, a family business might be ran as an S Corporation, with only members of the family holding shares of the corporation. Unlike a sole proprietorship, and S Corporation has a Board of Directors which oversee its activities. The liability of shareholders for the debts of the corporation are limited; the most they can lose is the amount they invested. (If the corporation goes bankrupt, creditors will not go after the personal possessions of the shareholders.) When the corporation earns money, it can compensate its shareholders by passing money directly to them. The shareholders then must file their share of the S Corporation’s income on their personal tax returns. People employed by an S Corporation must pay themselves wages from revenues.

C Corporations (a.k.a. “Corporations”)
The firms that trade on the stock market are C Corporations; corporations that may be owned by an unlimited number of shareholders. They, too, all have a Board of Directors, and limited liability for shareholders. Unlike S Corporations, C Corporations are taxed directly, and the dividends that they pay to their shareholders cannot be deducted from their income. Many people complain that it is bad for corporations to pay dividends, as they are taxed on the money, and then the people receiving the money are taxed on it as well (i.e. “double taxation”). To avoid this problem, corporations can choose not to pay dividends, and instead to invest their earnings in continued growth, leaving people to receive cash only through selling shares.

Which Corporate Structure is Right for You?
Unless you save a substantial money on taxes as a result of the structure, it is probably best to steer clear of forming a sole proprietorship. In industries where there is a substantial potential for liability, it is best not to operate in a manner in which your car or assets could be taken away in the event of an unfortunate lawsuit. It really probably is worth the extra paperwork to avoid this structure. Both LLCs and S Corporations can be held by one or a few individuals, and offer limited liability protection.

If you are planning on starting a small business with a few owners, a S Corporation will enable you to create shares to spread among the group. However, if you envision your business being publicly held, or held by over a hundred shareholders, a C Corporation will be a necessity.

1 Comment

  1. Anne

    As a contractor who is asked to subcontract (no W2 allowed)sometimes, I put together an S Corporation. It’s the perfect vehicle for a one-man show / entrepreneur start-up type of business. You don’t need anyone else to form it and run it. It’s simple for taxes, too. Forming an S-Corporation is fairly easy, too. You can get details at the Secretary of State site for your US state that explain the basics. And there are all sorts of non-lawyer services that will do your initial filing for you after you fill out a form to describe your business. Incorporating is a lot easier than most people expect.

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