Comparing Business Forms & Structures

There are many entity types and structures. Understanding the differences will help you make the right choice. The following discussion compares the most common forms and structures.

• Corporations compared to sole proprietorships & partnerships
• Corporations compared to LLCÕs
• C-corporations compared to S-corporations
• LLC’s compared to S-corporations

Corporations compared to Sole Proprietorships & Partnerships:
Corporations enjoy many advantages over partnerships and sole proprietorships. But there are also disadvantages. We cover the most important upsides and downsides below.

Advantages:
Stockholders are not liable for corporate debts. This is the most important aspect of a corporation. In a sole proprietorship and partnership, the owners are personally responsible for the debts of the business. If the assets of the sole proprietorship or partnership cannot satisfy the debt, creditors can go after each owner's personal bank account, house, etc. to make up the difference. On the other hand, if a corporation runs out of funds, its owners are usually off the hook.  Please note that under certain circumstances, an individual stockholder may be liable for corporate debts. This is sometimes referred to as "piercing the corporate veil." Some of these circumstances include:

• If a stockholder personally guarantees a debt.
• If personal funds are intermingled with corporate funds.
• If a corporation fails to have director and shareholder meetings.
• If the corporation has minimal capitalization or minimal insurance.
• If the corporation fails to pay state taxes or otherwise violates state law.

Self-Employment Tax Savings. Earnings from a sole proprietorship are subject to self-employment taxes, which are approximately 15%. With a corporation, only salaries (and not profits) are subject to such taxes. This can be a significant savings.

Continuous life. The life of a corporation, unlike that of a partnership or sole proprietorship, does not expire upon the death of its stockholders, directors or officers.

Easier to raise money. An corporation has many avenues to raise capital. It can sell shares of stock, and it can create new types of stock, such as preferred stock, with different voting or profit characteristics. Plus, investors will rest assured that they will not be personally liable for corporate debts.

Ease of transfer. Ownership interests in a corporation may be sold to third parties without disturbing the continued operation of the business. The business of a sole proprietorship or partnership, on the other hand, cannot be sold whole; instead, each of its assets, licenses and permits must be individually transferred, and new bank accounts and tax identification numbers are required.

Disadvantages:
Higher cost. Corporations cost more to set up and run than a sole proprietorship or partnership. For example, there are the initial formation fees, filing fees and ongoing annual state fees.

Formal organization and corporate formalities. A corporation can only be created by filing legal documents with the state. In addition, a corporation must adhere to technical formalities such as shareholder minutes and meetings. If these formalities are not kept, the stockholders risk losing their personal liability protection. While keeping corporate formalities is not difficult, it can be time-consuming. On the other hand, a sole proprietorship or partnership can commence and operate without any formal organizing or operating procedures.

Corporations compared to LLC’s:

Advantages of Corporations:
Profits are not subject to self-employment taxes. Salaries and profits of an LLC are typically subject to self-employment taxes, of approximately 15%. With a corporation, only salaries, and not profits, are subject to such taxes. This can be a significant savings.

Greater Acceptance. In some cases, banks or vendors may be reluctant to extend credit to limited liability companies due to their non corporate structure. Moreover, there are restrictions as to the type of business that an LLC may conduct in some states.

Greater variety of, and fewer taxes on, fringe benefits. Corporations offer a greater variety of fringe benefit plans than any other type of business entity. Various retirement, stock option and employee stock purchase plans are available only for corporations.

Tax Flexibility. Although C-corporations are subject to double taxation, they may provide for less overall taxes than the LLC. Further, a C-corporation does not have to immediately distribute its profits to shareholders as a dividend.

Ability to use the cash method of accounting. Unlike a C-corporation, which often must use the accrual method of accounting, most limited liability companies can use the cash method of accounting. This means that income is not earned until it is received.

A corporation maintains an unlimited life while an LLC has a limited existence. Absent a contrary agreement, a limited liability company (LLC) is dissolved upon the death, withdrawal, or bankruptcy of a member unless the business is continued by unanimous vote of the remaining members. Although the operating agreement can be drafted to avoid such a result, the life of the LLC is still limited to the termination date in the Articles of Organization.

Disadvantages of Corporations
More corporate formalities. Corporations must holding regular meetings of the board of directors and shareholders and keep written corporate minutes. Members and managers of an LLC need not hold regular meetings, which reduces complications and paperwork.

Ownership restrictions for S-corporations. S-corporations cannot have more than 75 stockholders, and each stockholder must be an individual who is a resident or citizen of the United States. Also, it is difficult to place shares of an S-corporation into a living trust. None of these restrictions or difficulties apply to an LLC.

Shareholders of C-corporations cannot deduct operating losses. Members who are active participants in the business of an LLC are able to deduct operating losses of the LLC against their regular income to the extent permitted by law. Shareholders of an S-corporation are also able to deduct operating losses, but not shareholders of a c-corporation.

C-corporations compared to S-corporations:

C-corporations are subject to double taxation; that is, one tax at the corporate level on the corporation's net income, and another tax to the shareholders when the profits are distributed to them. S-corporations, on the other hand, have only one level of taxation. All of their income is allocated to their stockholders. This is often a significant tax advantage.

S-corporations are subject to limitations, such as the number and type of stockholders it can have. Navigating these restrictions can be tricky.

Fringe benefits are easier to deduct in a C-corporation.

Capital may be easier to raise in a C-corporation.

Equity incentives are easier to offer to employees in a C-corporation.

To become an S-corporation, elections are needed at the federal level and possibly state level too.

Not all states and localities recognize the S-Corporation.

LLC’s compared to S-corporations:

An LLC profits are typically subject to self-employment tax while an S-corporation’s profit is not. This can be a significant tax savings.

An LLC has more operating flexibility and less corporate formalities than a S-corporation. For example, an S-corporation cannot have more than 75 stockholders or any non resident shareholders and must hold periodic meetings.

An LLC may specially allocate profits or losses in a different ratio than the members’ interest in profits, unless the articles of organization or operating agreement provide otherwise. S-corporations cannot do this as it would create a second class of stock. This may be a big tax advantage for an LLC where it’s members’ make different capital contributions.