Often times a client will come to us with a type of business entity in mind that they want to form. Other times a client knows that they want to form a business entity, but has no idea what type to form. Complicating the determination is trying to look down the road months or years into the future to determine what issues and problems the potential business may face and which form of entity will be best to address the future’s twists and turns. And with S corporations, C corporations, partnerships, limited partnerships, and limited liability companies, the selection process is not always easy. Below is a brief overview of the different types of entities.
“C” or regular corporations, taxed at the corporate level and again at the shareholder (equity owner) level upon distribution of dividends, i.e. company profits, for federal income tax purposes. Corporations provide a strong measure of liability protection for the shareholders as against company debts and liabilities (well not for personally guaranteed debts of the business as required by banks and other creditors from time to time).
“S” corporations, which are mostly taxed only at the shareholder level for federal income tax purposes (even when no distributions are made to the shareholders). Many of these are incorporated under state for profit corporate/business laws as with the “C” corporations but must elect “S” status with the IRS and otherwise qualify under the Internal Revenue Code, Sections 1361 and 1362, Internal Revenue Code.
Sole proprietorships require no formal organization with the state. As a sole proprietorship is essentially an unincorporated business with only one owner. Each owner has unlimited personal liability for the debts and liabilities of the business. For federal income tax purposes, there is only one level of tax, i.e. imposed on the owner.
Partnerships, which require no formal organization with the state save for limited partnerships (i.e. those offering some equity to limited partners with limited powers and authority). These must-have two or more equity owners. General partners have unlimited personal liability exposure for the debts and liabilities of the business while limited partners do not. For federal income tax purposes, there is only one level of tax, i.e. on the partners, limited or general.
LLCs, which are roughly hybrid entities of corporations and either sole proprietorships or partnerships depending upon the number of equity owners. These must be formed by state secretary of state as with corporations. LLCs offer perhaps the most flexibility for tax and non-tax reasons in that LLCs offer a single level of tax (i.e. generally as either a sole proprietorship or partnership) sans the complexity and restrictions of “S” corporations, while providing the limited liability protections afforded the equity owners of most kinds of corporations. Note also that an LLC can be taxed as a “C” or “S” corporation, sole proprietorship or partnership. Due to the flexibility in tax and other areas, the LLC is the default choice of many practitioners.
We have formed businesses, small and large alike, in Minnesota, Wisconsin, Iowa and Arizona. If you need your business formation questions answered, reach out to us.