Types of business structures - Which is Right For You?

Generally, as a brand new small business, you will start as a sole proprietorship; this means that as far as your taxes are concerned, there is no difference between you as an individual and your company. As you expand and grow, however, you may want to revisit the structure of the business. It is in an expansion that many small companies shift and become incorporated.

If you hire on staff, buy real estate and purchase equipment, the need to incorporate becomes even more pressing. Two of the leading corporate structures for which you can opt are an S Corp and a C Corp. Understanding the difference between these will help you to decide which makes the most sense for your specific business.

Understanding the Basics Behind Corporate Structures

In reality, there are five different types of company structures that a business can fall into sole proprietorship (as mentioned/), partnership, corporation, LLC and cooperative.

The S and C Corps fall under the corporation designation; whereas, the others in this list have their unique structure and following benefits, as well as some drawbacks. Let’s briefly look at what each of these entails.

Sole Proprietorship

Again, a sole proprietorship is generally where most new companies start. It’s a natural structure to set up and maintain. Keep in mind, that with this type of set up, you as the company owner are solely responsible for everything associated with the business; that is to say, any debt, financial problems, anything of that nature will fall back on you as you have complete liability with a sole proprietorship.

Partnership

In a partnership, multiple partners take on the liability for the company. As such, those involved all share in the company debts as well as in the company profits.

Corporation

A corporation has its own identity apart from the owner or owners. Those who do own a corporation are stockholders. The board of directors comprises of said stockholders. With a corporation, no one person is liable as the company is its entity.

Limited Liability Company (LLC/)

An LLC or limited liability company essentially blends the structure of a corporation with that of partnership. There is a similarly limited liability aspect to an LLC that those involved in a corporation can also benefit.

Cooperative

Cooperatives are organizations owned by a group. So, for instance, a credit union would be considered a cooperative. The company thus acts in terms of the best interests of its members.

S Corp versus C Corp

Both S and C Corps are formal corporations, meaning that the owner of the company does not bear liability—the business, in other words, is a separate entity apart from the owner.

C Corp

From both a legal and financial standpoint, the owners of a C Corp do have limited liability. So, if an issue of either of these does come up, the owner(s/) would more than likely be free and clear as far as the legal and monetary end of things.

Where it does differ from an S Corp (in one of the more notable ways/) is as it relates to taxation. With a C Corp, come tax time, you can be taxed both on the business’s revenues as well as on the dividends that you receive under your shareholder status.

C Corps, unlike S Corps, do have to pay corporate income tax. Generally, larger US-based companies tend to be C Corps.

S Corp

Not as common as a C Corp, an S Corp is also a shareholder based structure which gives said shareholders limited liability status. The difference, however, is that S Corp owners get pass-through taxation. What this means is that unlike with the C Corp, there is no double tax. Just the owners get taxed—the business itself is not taxed.

Which Should You Set up for Your Company?

The only thing you need to keep in mind when creating either your C Corp or S Corp is that the S Corp is established by filing IRS form 2553 along with the general incorporation process. With both types of entities, you will need to do the following:

• File your articles of incorporation
• Appoint a Board of Directors
• Draft bylaws
• Issue stock certificates

As mentioned, there are some distinct tax advantages/drawbacks to both. Before finally deciding on which you want to form, an S or C Corp, you should carefully consider the tax ramifications of each.

The S Corp is again a pass-through structure—so you avoid double taxation. Because the profits go through the shareholders’ taxes, the rate may be lower than what the corporate tax rate is—this will also depend on what state you live.

With an S Corp, you have to have fewer than 100 shareholders. However, the tax filing process is a lot easier and more streamlined. Many do see the lengthy tax process of a C Corp filing, not to mention the double-tax factor as a drawback to this type of entity.

Overview of S and C Corps

The answer would seem pretty straightforward as far as which is a better fit for a small business looking to incorporate. With the S Corp, you get the pass-through taxation rather than being taxed both personally and on the business side. You want to be sure that you familiarize with IRS protocol and rules regarding establishing either of these corporate types.

Considering long term goals, and basically which is a better fit for you and your overall plans is undoubtedly essential. If you do wish to raise capital and ultimately sell the stock, then the C Corp might be a better choice. It would be best if you took the time, do your homework and choose the best possible structure for your business.

At First Union, we love giving advice to small business owners. We like to see businesses thrive. Call today to speak to one of our agents!