If you decide to go into business, you must choose
how to structure the business. Operating as a sole
proprietorship is the easiest approach: you don't
have to fill out any startup forms, and you'll have
little ongoing paperwork to handle. However, sole
proprietorships are personally liable for claims against
the business. Furthermore, raising capital for a sole
proprietorship can be difficult; thus, most business
owners who envision a growing company choose another
form of business entity.
C corporations
This structure is also known as a "regular"
corporation because it has been the norm. If you hold
shares of a publicly traded company, you probably
are part owner of a C corporation.
Business owners may have many reasons for incorporating,
including limited liability. That is, shareholders
generally are not personally liable for the company's
debt. If the company is sued or files for bankruptcy,
the owners' personal assets are not at risk.
There are drawbacks to operating a company as a C
corporation, however. You must comply with requirements
for filings, corporate minutes, and so forth. Perhaps
most important, C corporations are subject to the
corporate income tax. Your C corporation may be taxed
on its net income for the year. In addition, if the
company passes out some of those profits to you, you'll
owe tax on that dividend income. Therefore, some dollars
will be subject to double taxation. On the other hand,
if your C corporation has a loss, you'll receive no
direct tax benefit.
S corporation
With an incorporated business, you also may be able
to elect S corporation status. In order to make this
election, your company must meet certain requirements.
It must have no more than 100 shareholders, for example,
and none of those shareholders can be other corporations
or nonresident aliens. In addition, an S corporation
cannot have more than one class of stock.
If your company qualifies for S corporation status,
you will enjoy the same limited liability granted
to C corporation shareholders. In addition, S corporations
can deliver tax benefits. Losses are passed through
to individual shareholders (and can be deducted to
the extent of their basis in the corporation), and
the company owes no corporate income tax on any profits.
Example 1:
Bill Benson and Sarah Sanders form a corporation and
elect S corporation status. They each owe 50% of the
shares. In the first year of operation, the company
loses $30,000. Bill reports a $15,000 loss on his
personal income tax return, which he can deduct from
other income. Sarah also reports a $15,000 loss.
Example 2:
In the following year, their S corporation reports
a $200,000 profit. Bill and Sarah each report $100,000
of profits on their personal income tax return, but
their company does not have to pay any corporate income
tax. Thus, Bill and Sarah avoid the double taxation
that C corporations and their owners may have to pay.
Limited liability company
These entities, commonly known as limited liability
companies (LLCs), have gained popularity recently
among small business owners. In some ways, LLCs offer
S corporation advantages without the disadvantages.
Like S corporations, LLCs offer limited liability
to the business owners, known as members. LLCs also
avoid corporate income tax while allowing members
to deduct their share of any losses incurred by the
business (to the extent of their basis in the LLC).
What's more, you don't have to meet the S corporation
requirements to form an LLC. You can organize your
LLC to have one class of membership, for instance.
Because LLCs are relatively new, investors and lenders
may be more comfortable with businesses structured
as corporations. Toscano & Ardito can help you
decide which business structure is most suitable for
your company.
Source: January, 2010 CPA
Client Bulletin; a monthly publication of the AICPA)
