When starting your business, you may be classified as a partnership, corporation, LLC or a sole proprietor. Each form of business has its own advantages and disadvantages. For example, partnerships are much easier and less costly to form in most cases, when compared to a corporation or an LLC.
Corporations are the largest of all business entity types. The two types of corporations are C corporations and S corporations. S corporations are smaller businesses that have fewer than 75 shareholders. C corporations, on the other hand, may have hundreds or thousands of shareholders.
In addition to the number of shareholders, large corporations have a complex structure consisting of directors, managers and employees. Due to the size of corporations, company decisions are voted on by shareholders and the company's board of directors.
Limited liability companies may have one owner or an unlimited number of members. In addition to members, limited liability companies may have managers and employees who are responsible for day to day operations.
Partnerships must have at least two owners. In some instances, a partnership will consist of several business owners. Partnerships may have employees, but the partners are usually involved in the operation of the business.
A major drawback of a corporation is the issue of double taxation. C corporations experience double taxation because corporate profits are taxed, as well as dividends distributed to shareholders. Dividends are taxed on the shareholder's personal income statement.
S corporations may bypass double taxation by passing the ownership interest in corporate profits and losses, through to the shareholder's personal income tax return. LLCs that elect to be taxed as a partnership, partnerships and S corporations share the ability to pass company profits and losses through to the owner's income tax return.
Corporations enjoy tax advantages such as the ability to write off the expense of providing medical benefits to employees. Salaries, bonuses and advertising costs are examples of deductions enjoyed by corporations. In some cases, the rate at which corporation profits are taxed may be lower than your personal income tax rate.
Additionally, corporations and limited liability companies are audited less frequently than partnerships. This is because corporations are required to keep strict records and meet accounting standards. The IRS is aware that partnerships are less formal and may not have adequate accounting systems in place.
One of the major advantages corporations and limited liability companies have over partnerships is limited liability. If you form a corporation or an LLC, your liability is limited to your ownership interest in the business. For example, if your corporation gets hit with a lawsuit, as long as your business has followed all procedures to remain a corporation, your personal assets won't be in harm's way.
Partnerships have no liability protection if a general partnership is formed. All partners are jointly responsible for occurrences in the partnership, unless otherwise stated. Limited liability partnerships and limited partnerships offer more asset protection compared to general partnerships.
Forming a corporation requires the most paperwork of all business entity types. Corporations are required to file corporate bylaws and articles of incorporation, keep a record of minutes, issue initial stock, elect officers and form a board of directors.
Corporations are required to prepare annual reports each year. All appropriate documents must be kept on file with the Secretary of State, and meetings must be held in your state of operation.
Limited liability companies involve much less paperwork than a corporation. Limited liability companies are encouraged to create bylaws and an operating agreement that indicates ownership interests, as well as how profits of the business should be divided.
Partnerships require very little paperwork and are one of the easiest business entities to form. When entering a partnership, it's advisable for you to create a partnership agreement, detailing how you will split ownership interests and profits.
Raising capital is often easier for a corporation compared to other business entities. If a corporation wants to raise more money, it can sell more company stock or issue a new class of stock in the case of a C corporation. S corporations can only issue one class of stock. Furthermore, corporations seem to have more credibility with investors and lending institutions.
Other business entities don't have shareholders. Limited liability companies and partnerships lack the ability to issue stock. If you have a new small business, with few owners or stockholders, you may find it difficult to raise capital, even if you're a corporation. This is because lending institutions prefer to lend to established businesses with a proven track record of performance in their industry.