One of the challenges faced by most small business owners is how to choose the best business structure. Choices include sole proprietorship, partnership or corporations. Among corporations, there is the additional choice of C or S. Or the small business owner may consider a limited liability company, commonly referred to as LLC, which is not a corporation, but which does offer some similar benefits.

A sole proprietorship can be created easily by almost anyone at any time who decides to start a business. By contrast, starting a C or S corporation or a LLC requires additional paperwork to be filed within the state in which the business operates, and subsequently, there are associated filing fees. In fact, the need to file is perhaps is one main reason many new small business owners hesitate to incorporate. However, depending upon your individual business and your plans for growth, you may want to look more carefully at your options.

Take a look at the following table for a quick overview of the basic differences between these main business structures.

Now let's consider some of these characteristics in more detail.

Limited Liability Companies (LLC)

As mentioned above, both LLCs and corporations are formed when the appropriate paperwork is filed. To create a LLC, you choose a name for your business and file articles of organization within the state of operation. It is important to note that each state’s regulations vary, so make sure you check with the state in which you operate for specific requirements.

• As its name implies, owners of the LLC have limited liability for debt or other legal obligations. In most cases, the entity itself, not the owner(s), is liable.
• Income taxes are not paid by the LLC, but are passed through to the owner(s) so there is no double taxation as in a C corporation.
• The lifetime of the LLC is not tied to the lifetime of its owner, so it can continue even after the death of its owner(s).
• LLCs are relatively simple organizationally. Unlike corporations, there is no required board or directors nor annual meetings.

LLCs are becoming more and more popular with small business owners, most likely because they are relatively simple to manage and offer a straightforward, business structure. In fact, the number of new LLCs created each year exceeds corporations by approximately two to one.

Corporations

To create a corporation, you need to file articles of incorporation in the state or states in which you plan to do business. By so doing, you establish the name of the business, its board of directors and policies governing shareholders.

• The corporation, not individual shareholders, is liable for any debts or other legal obligations. Though the corporation itself can be sued or otherwise held ccountable, the individual shareholders cannot. This layer of protection can be especially attractive in a shaky economy.
• The lifetime of a corporation is not tied to that of any one individual shareholder. In other words, a corporation will continue in perpetuity even if its founder dies or otherwise dissociates from the business. The only way that a corporation can cease to exist is if its board votes to dissolve or terminate it.
• Investors may find this type of business entity more attractive than sole proprietorships

Overall, corporations are more complex than other types of business structures. And almost nothing is more complex than the IRS’s tax codes. This is where the distinction is made between C and S corporations.

C Corporation and Taxation

According to Chapter 1, Subchapter C of the Internal Revenue Service’s tax code, a C corporation is taxed as a business entity separate from its owners. In addition, its owners, i.e. its shareholders, may also be taxed for any dividends they receive. Thus C corporations are commonly referred to as being double taxed. Obviously, this double taxation is an important consideration for small business owners who are trying to choose the best structure for their businesses.

While double taxation can be seen as a major disadvantage of C corporations, there are some other tax advantages. For example, even if it reports losses for several years, a small C corporation is less likely to be audited than its counterparts, such as the sole proprietorship or partnerships. Also, some employment benefits, such as the cost of health care insurance, can be 100 percent deductible.

S Corporation and Taxation

Just as the C corporation is an IRS designation, so is the S corporation, which is based upon Chapter 1, Subchapter S of the IRS tax code. One main advantage of an S corporation is that there is not the same double taxation that is found in C corporations. Income and loss are passed through to the individual shareholders. Often, new business owners are encouraged to create an S corporation, but it is always best to consult a tax specialist before making this decision.

It is important to remember that C and S are tax designations only, as defined by the Internal Revenue Service. This is not to be confused with each individual state’s regulations governing the formation and operation of a general corporation.

Regardless of the structure you chose for your business, you can always change as your business changes. But remember, making the right decision before you even begin your business is always the best choice.