When you come to start a new business, one of the first things you must do is figure out which one of the types of business entities you think is best for your company. To understand which one you are going to choose, here is a breakdown of the different types available to you and what they offer in comparison to the other types. Bear in mind, all of the options discussed have pro and cons so you need to weigh up your options.
A corporation is a separate legal entity from the owner of the business and as such means that they are protected from the company’s liability and debts. In addition to a layer of protection for the owner, a corporation can also raise additional funds through the sale of stocks which means the ownership can be transferred based on share allocation. This type of business entity comes with its own rules, as they all do, and for a corporation, it starts with the structure of the business which is as follows:
- Directors (elected by shareholders)
- Officers (appointed by directors)
- Officers run day to day business
Some of the cons of a c-corp include that it can be expensive to start one and there tends to be more paperwork than an LLC, which we all come onto later.
C-corporations can transition themselves to s-corporation and the reason for doing that tends to be for tax reasons. There are more restrictions on an s-corp than a c-corp, but there are positives such as the distribution of tax being different. By operating as an s-corp the shareholders can take on the income and losses of the business and write it off in their personal income tax. This means that s-corps avoid the double taxation that c-corps have to pay.
Double taxation means paying personal income and corporate tax.
S-corp is something that small business owners prefer but as a company grows they may choose to switch back to c-corp. This is because the former can only have under 100 shareholders who are citizens of the company’s home country which is not the case with the latter.
Limited Liability Company (LLC)
Often described as a combination of a corporate structure and a partnership, an LLC allows flexible ownership without stock options and the ability to choose how it is treated when it comes to taxation. Like a corporation an LLC is considered separate to the owner and therefore their assets are not liable in the case of debt.
Over 80% of small businesses choose to operate as an LLC for the above reasons as well as the option for it to be taxed as a sole proprietor without the risk to the owner that a DBA has. However, an LLC may opt to be taxed as a c or s-corporation if the company’s finances tend to fluctuate.