By Rieva Lesonsky
The biggest reason small business owners choose to incorporate or form a limited liability company (LLC) legal structure is to protect themselves from the financial and legal liabilities associated with owning a business. Don’t assume you can’t incorporate just because you’re a one-person operation—but do know that the IRS has specific rules set up to make sure small business owners don’t abuse the system. Here’s a look at the different forms of business corporations so you can make a S Corp vs. LLC vs. C Corp comparison.:
A corporation must file articles of incorporation with the state and hold annual shareholder meetings, including taking minutes. Even if you’re the only shareholder, you must be in compliance with these procedures. Owners and shareholders are not personally or financially responsible for the corporation’s debts and responsibilities; shareholders are only responsible for their own investments. If there are dividends paid, shareholders can be taxed on those profits received. The corporation pays taxes on its profits and can claim its losses. As a separate entity, it continues to exist even after the death of a shareholder or transfer of the shareholder’s shares.
In a C corporation, companies can sell stock or shares with no limit on the number of shareholders. Public companies must be structured as a C corporation. Owners of a C corporation pay a double tax: The earnings of the company are taxed, and shareholders pay taxes on any dividends received. However, if the owners take a salary, the corporation is not required to pay tax on those earnings; the salary payments are considered a business expense.
An S Corporation pays no federal income taxes. Instead, the business’s income and losses pass through to the shareholders, who report them on their personal tax returns. This method is considered “single taxation,” in contrast to a C corporation’s “double taxation.” While it may seem more attractive to be taxed only once, shareholders are taxed for any income the company has, even if they did not receive any portion of that income, where with a C corporation, shareholders are taxed only if dividends are issued. In addition, S corporation officers must be paid a “reasonable salary” even if the company isn’t profitable, and the company is limited to a maximum of 100 shareholders.
Limited Liability Company (LLC):
LLCs file similar articles of organization with the state, but can have a more flexible management structure than a corporation requires. The LLC protects members from personal liability in case of judgment or debt; however, profits and losses are reported on each owner’s individual tax return. That makes the LLC more suited to a one-person owner, because shareholders may not like the pass-through taxation. If there is only one owner/member, the company’s income is reported on the individual’s Schedule C. If there is more than one owner, the individuals are treated as a partnership.