Incorporating your business automatically makes you a regular or “C” Corporation (C Corp). Among the different types of business structures, virtually all the larger, publicly traded companies are C Corporations, but the benefits of this business structure extend to businesses that are still in the idea phase. Basically, a C Corp creates a separated entity for the incorporated business, which is viewed as a separate taxpayer by law (with income and expenses taxed to the corporation, not the owners). This helps protect the owners personal assets from lawsuits and creditors.
C Corp Pros:
- VC Funding: If you’re planning on raising institutional investmentsin the future (i.e. venture capital funding), VC’s like to invest in Delaware-incorporated C Corporations (this has become de-facto because instead of learning the laws of every state, the VC’s can just master the C corp laws of Delaware – plus C corporations provide more flexibility in making ownership arrangements). VC’s typically don’t invest in LLCs and are unable to invest in S corporations.
- IPO’s: In general, only C corporations can go public.
- Limit Liabilities: Due to the fact that C corporations are legally a separate entity than the owners (shareholders), the owners cannot be held liable for any debts of the C corp or any lawsuits brought against it.
- • Stock Benefits: C corps can sell stocks or shares (either common or preferred stock), with no limits to the number of shareholders. A C corp also allows you to offer employees stock option plans.
C Corp Cons:
- Filing Fees: C corps must pay a few different state and federal filing fees and each state has its own set of regulations. Dealing with these regulations may require the assistance of a professional (business attorney or CPA).
- Paperwork: More paperwork must be filed compared to an LLC (including but not limited to: articles of incorporation, bylaws, minutes, certificates of good standing, etc.)
- Double Tax: Owners of the corporation must pay a ‘double tax’ on the earns of the company as well as taxes on the dividends they receive (this does not include owner salaries).
Limited Liability Company
A limited liability company (LLC), is a type of private business organization which offers the the owners (or member of the LLC) various benefits. To simplify an LLC, it provides the LLC members pass-through taxation similar to a partnership or sole proprietorship with limited liability of a corporation.
- Tax Flexibility: you have the flexibility of being taxed under sole proprietor, partnership, S corp, or C corp regulations.
- Less Paperwork: Due to LLC’s being less complex business structures, you will have less paperwork to file in order to establish an LLC
- Lower Filing Fees: Due to there being a less complex
- Liability Protection: LLC’s protect your personal assets from debt collectors or lawsuits brought against your business. This ensures that if the business ends up in debt, that your assets won’t be used as collateral to pay off any loans.
- Flow-through Income Taxation: This structure allows for profits that are earned by an LLC to be reported directly on members’ individual tax returns, preventing the ‘double taxation’ that C corps would face.
- Raising Money: Due to the structure of the ‘pass-through’ tax system as well as the lack of a strict corporate structure, an LLC may run into troubles raising money from larger investment firms.
- Additional Taxes: Though LLC’s don’t have the ‘double taxation’ that C corps sometimes face, many states such as California, New York, and Texas require LLC’s to pay a franchise tax or a ‘capital values tax.’
- Less Structure: This could be a pro or a con depending on how you want to operate your business, but unlike a C corp, there’s not much structure governing the operation of your LLC.
Subchapter S/S Corporation
A Subchapter S (or an S Corporation/S Corp) is a corporation that meets the IRS requirements to be taxed under Subchapter S of the IRS Code. Essentially, an S corporation pays no income tax (the tax is passed through to the shareholders, who report them to the IRS on their individual returns) and may only be used for small businesses.
S Corp Pros:
- No ‘Double Taxation’: In an S Corporation profits and losses are passed through to the shareholders, therefore avoiding the ‘double taxation’ sometimes seen in C Corps (the taxing regulations for S Corps vary from state to state though, so be sure to check your state’s rules regarding S Corp taxation).
- Protection From Liability: An S Corp provides the same protection on your personal assets as a C Corporation.
- Easier Accounting: S Corporations can use the cash method of accounting, which is simpler than the accrual method (unless the S Corp has inventory). Check with your CPA to figure out which option makes the most sense for your business.
S Corp Cons:
- Regulations and Fees: Like a C Corporation, S Corps are required to fill out a bunch of state and federal documents, including Articles of Incorporation and corporate minutes. They also must conduct more formal business practices like regular shareholder meetings.
- Shareholder Restrictions: With an S Corporation, the shareholders will be taxed for any income the company has, even if they did not receive any portion of that income (as opposed to a C Corporation, when shareholders are taxed only if they receive dividends). S Corporations may also only issue one class of stock, and are limited to under 100 shareholders in total.
- Salary Requirements: The IRS requires that all owners and officers of an S Corporation must make a salary, even if the company is not making a profit. This can cause issues for companies that are struggling to make payroll, as they must give their employees a “reasonable salary” (that is, a ‘fair market’ salary).
- Must Be A Domestic Corporation: You may only have domestic individuals and qualifying trusts as shareholders.
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A sole proprietorship is an unincorporated business with one owner who pays a personal income tax on the profits from the business. These are the simplest types of businesses to set up, as there are few government regulations on sole proprietorship businesses.
Sole Proprietor Pros:
- Speed: Sole proprietorships are the easiest type of business formation to set up, and thus, the fastest. There are very few government restrictions and only a few forms that you must fill out before you’re in business.
- Control: Solely you make all the business operation decisions, as well as control all of the money made by the business. This allows you to respond more quickly to day-to-day changes and decisions that need to be made.
- Less Paperwork: Due to the limited government control and taxation on sole proprietorships, you don’t need to keep detailed incorporations records or conduct annual corporate reports. You also don’t have to make a separate tax return for the business and you also don’t have to prepare a balance sheet.
Sole Proprietor Cons:
- Major Liability: As a sole proprietor, you are held liable for ALL business debts. Therefore, if your business falls into debt, you will be held responsible for paying back any outstanding debts of the business. This liability includes all of your assets, including your house and car. The purchasing of additional insurance may be needed to cover any personal injury or physical loss that could prevent the business from continuing.
- Fundraising: It is inherently more difficult for sole proprietors to raise cash from investors, or set up long-term financing due to the structure of the business as well as the liabilities involved.
- Loss of Professionalism: Many view a sole proprietorship as being ‘less professional’ than a more formal limited liability company.
A general partnership is a business arrangement where the partners within a joint venture have unlimited liability (meaning their personal assets are liable to the partnership’s obligations). Since all partners have this unlimited liability, even fully innocent partners can be held responsible when another partner commits an illegal act.
General Partnership Pros:
- Tax Benefits: Businesses structured as partnerships do not pay an income tax and have the taxes ‘passed through’ to the individual partners, who file the income on their personal tax return.
- Less Paperwork: Simply put, establishing a general partnership is simple, cheap and requires less paperwork than a corporation. The partnership simply must file an official partnership with the county where it does business.
General Partnership Cons:
- Liabilities: A general partnership creates a personal liability for the owners for all of the business’s debts. If the company is sued, all the fines are the individual partners’ responsibility. Many partnerships also allow any partner within the company to make business decisions at their sole discretion. Even if a partner is acting on their own behalf for the company, all partners within the company are held responsible for that decision.
- Management Problems: Due to the fact that partners may make investments from their personal finances and all partners of the partnership then owe the debt, reimbursement issues can appear. Having all partners equal in power and responsibility can create hierarchical issues within the company as well unless operating guidelines are in place from the get-go.
- Limited Life: A general partnership is defined by the partners involved, and therefore, the partnership is terminated when any one of the partners leaves the business or is physically incapacitated (unless an operating agreement is established which defines what happens in those cases).
Benefit Corporations (or B Corps) are a type of for-profit corporate entity that is legal in about 30 states and include positive impact on society and profit as its legally defined goals. B Corps differ from C Corps in purpose, accountability, and transparency, but are governed under the same tax rules. Instead of corporate decision making being protected by the business judgment rule, B Corps have a fiduciary duty to consider non-financial stakeholders while making business decisions (allowing directors to make more mission-driven and less profit-driven business decisions).
Benefit Corporation Pros:
- Branding: Being defined as a B Corp certifies you as a ‘good an ethical business’ through a 3rd party process, setting you apart from other competitors that are not B Corps. This can become an effective marketing tool with accreditation that your business is truly supporting the environment.
- Institutionalized Social Missions: With B Corps, the business is not obligated to make decisions based on the interests of their shareholders and the company profits. This allows the directors of the company to be legally protected to make decisions based on non-financial goals (which is untrue of other corporation types).
- Press Opportunities: News organizations inherently like to write about B Corps due to their general recentness and their tendency to help better society.
Benefit Corporation Cons:
- Legal Uncertainty: Due to B Corps being such a new entity, there is a little legal uncertainty surrounding the business formation. If you’re planning on establishing a B Corp, it’s suggested to hire an attorney who specializes in that type of business.
- 3rd Party Auditing: You must maintain your B Corp status by passing random audits throughout the year. If you fail one of these audits, and can’t prove you are staying true to your stated mission, then there’s a possibility for you to lose your B Corp certification.
- Not Available Everywhere: Currently, B Corps are only legal in about 30 states. There’s a movement to make them legal across the U.S., but if you happen to be in one of the states that it is not currently legal in, you may be out of luck.
- No Added Tax Benefits: There aren’t any tax benefits that come with a B Corp vs. a C Corp, so you may just be adding more stress to your company to pass random audits if the B Corp benefits don’t relate to your business.
A nonprofit organization is a non-business entity (or an organization) whose purposes are other than making a profit and qualify as a public charity under Internal Revenue Code 501(c)(3). This means that the nonprofit is dedicated to a particular social cause and uses its surplus revenues to further its purpose or mission (rather than distributing it among the organizations shareholders as profits).
- Eligibility For Grants: Nonprofits are allowed to solicit charitable donations from the general public, as well as receive grants from the federal government.
- Limited Liability: Similar to a C Corp, nonprofit organizations provide liability protection for its directors. Personal liabilities are not eligible for collateral for any business debt.
- Major Tax Breaks: As a nonprofit, your company is eligible for state and federal corporate tax exemptions.
- Discounts: Many B2B businesses will offer discounted rates for their services for nonprofits.
- Length of Time to Establish: Applying for 501(c)(3) status not only is complex, but also an extremely lengthy process. Typically, it can take the IRS between 2 and 12 months to approve an application (sometimes there are also written follow-up questions after the application is submitted).
- Regulations: Nonprofits have very strict regulations ruling of their operations. They must submit annual reports to federal and state agencies, and if they are not compliant with the governing laws, a nonprofit may lose its nonprofit status.
- Pay: Nonprofits may only pay managers reasonable salaries, and may not divide profits to be shared. They also cannot pay their Board of Directors at all.
Limited Liability Partnership
A Limited Liability Partnership (or an LLP) is a partnership similar to a general partnership, but instead of all partners having an unlimited liability, they have a limited liability. This means that unlike a general partnership, in an LLP one partner is not held responsible for another partner’s negligence or misconduct.
Limited Liability Partnership Pros:
- Limited Liability: A partnership within a LLP is not held liable for any debts held by the company. Further, any partner is not held liable for any other partner’s decisions.
- Pass Through Taxation: Similar to a general partnership, LLP’s have pass through taxes to their partners (who report it on their personal tax return), and thus are not taxed at the business level.
Limited Liability Partnership Cons:
- Business Type Limitations: In some states, LLP’s can only be formed in businesses practicing licensed professions (i.e. law firms, accounting firms, etc.)
- Business Dissolving: Unlike corporations, unless a partnership agreement is in place, in the event of a partner’s death or incapacitation, an LLP can be dissolved.
Updated: January 7th, 2017