There are many different types of corporations. Each offers advantages and disadvantages in terms of taxes, paperwork, legal obligations, and other boring stuff.
Since we don’t have space to cover them all here, we’ll look at four major types: C, S, PC, and LLC (see the table below). Each is available in every state. It’s also possible to combine these basic types to create a variety of corporate formats.
|Feature||C Corporation||S Corporation||PC||LLC|
|What is it?||Standard corporate format||Similar to C, but owners elect to be taxed as partnership||Licensed professionals who incorporate to provide a service||Relatively new format; in some states must have at least two owners|
|Limited liability?||Yes||Yes||Liable for own actions; some protection against liability for others’ actions||Yes, for LLCs with two or more owners; liability issues untested for single-owner LLCs|
|Tax status||Corporation pays tax on profits; shareholders pay tax on all dividends they receive||Corporation usually not taxed; shareholders pay tax on profits as personal income||Similar to C corporation, unless owners elect to be taxed like S corporation||Similar to S corporation, unless owners elect to be taxed like C corporation|
The so-called “C” Corporation is the standard format. As with all corporations, when you establish a”C” Corporation, you create a separate legal entity with assets and liabilities that are entirely distinct from yours.
If a problem occurs, your liability generally is limited to whatever funds or other assets are actually owned by the corporation; your personal assets are protected. The “C” Corporation format can have other advantages too, such as flexibility for structuring pension plans and other owner benefits.
The “C” Corporation does have a major disadvantage: its tax status. If you own a sole proprietorship or partnership, you pay taxes once, because the Internal Revenue Service treats the company’s profits as your personal income. If you own a “C” Corporation, however, the corporation pays taxes on its profits, plus you pay taxes on any dividends that have been distributed to you.
The “S” Corporation offers the limited liability of a C corporation, but with a definite tax advantage: you can elect to be taxed for federal purposes as a partnership. This means that the income of your corporation is taxed as personal income only; you avoid the double taxation of the C format.
A “C” Corporation must meet certain criteria to be eligible for subchapter S election. (Among the requirements: You must have fewer than 75 shareholders and offer only one kind of stock). If you can satisfy these and other criteria, the S corporation may be a better choice from a tax perspective.
A professional corporation — sometimes called a Service Corporation (SC) or Professional Association (PA) — consists of licensed professionals who provide a service, such as accountants, doctors, dentists, or attorneys. All states have passed laws allowing professionals to incorporate. While they remain liable for their own professional activities, the PC protects them to some extent from liability for the actions of others.
The LLC is a relatively new way to organize a business. Like an “S” Corporation, the LLC offers the advantage of being taxed like a partnership. Multi–owner LLCs also offer the protection of limited liability.
If the LLC is a one–person enterprise, however, it is less clear whether this format limits liability to the same extent as other corporate formats. (Some states require an LLC to have at least two owners, although they can be spouses.)
The LLC may be more risky, precisely because it is new. While there are legal precedents for many tax and liability questions involving “C,” “S,” and professional corporations, these issues remain to be decided for LLCs.
Says Dee: “Until more of the legal ramifications are worked out, I advise people to seek legal and other counsel prior to forming an LLC.”