By Paul Prater
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01 Feb, 2021
Looking at different types of corporate entities can be confusing. Why are there so many and what do all of them mean? Before getting into the details, let’s start with a basic understanding of what a corporation really is. The word corporation is from the Latin corpus, which means body. In the eyes of the law, a corporation is a real person, an independent legal entity that is able to act like any living being; which means it can enter into contracts, own property and have debts and liabilities. The second thing to understand is that there are tax implications for each type, both at the state and federal level and this should have some bearing on the type of business that you should form. Now that we have a basic overview of what a corporation is, we will take a look at the specifics of the three most common corporate types for small businesses. C Corp is a bit of a misnomer. This is actually just a standard corporation and the earliest incarnation of a separate legal entity. It is often referred to as a C Corp in reference to section C of the IRS Code, which deals with corporation. Coincidence? I don’t know. Does anyone know the motives of the IRS? The Corporation provides personal protection from the debts of the entity, thus providing some personal insulation from risks of losing your assets in the event that the corporation goes under. There are more requirements to operate as a corporation and generally these can be somewhat burdensome to a small business without a fair amount of sophistication in regard to corporate requirements. However, they also have more options for growth and tax options. Corporations are formed under the laws of each state and are subject to corporate income tax at the federal and generally at the state level. In addition, any earnings distributed to shareholders in the form of dividends are taxed at individual tax rates on their personal tax returns. S Corp is short hand for small corporation. In a legal sense, from the perspective of corporate protections and liabilities, the S Corp is no different than the C Corp. The difference comes down to taxes. The S corporation allows income or losses to be passed through to individual tax returns, similar to a partnership. The rules for Subchapter S corporations are found in Subchapter S of Chapter 1 of the Internal Revenue Code. Generally, an S corporation is exempt from federal income tax other than tax on certain capital gains and passive income. It is treated in the same way as a partnership, in that generally taxes are not paid at the corporate level. An LLC is a limited liability company and was created as a more flexible and easy to maintain entity, which often makes them ideal for small businesses. Owners of an LLC are called members. Since most states do not restrict ownership, members may include individuals, corporations, other LLCs and foreign entities. Most states also permit “single member” LLCs, those having only one owner. The LLC also provides the same kind of protection as a standard corporation, so there are no drawbacks there. As for taxation, an LLC truly is a hybrid. The LLC can opt to be taxed at the corporate level or use pass through taxation. So which corporate entity is right for you? There is no correct answer. To really answer that question you need to discuss the particulars of your business goals with your attorney and accountant. Good luck on getting that business off the ground!