Business Structures Explained

Did someone say tax? That’s right, when you understand structure terms you can choose the right code and take advantage of tax benefits for businesses.

LLC or corporation?

Unless you are planning on taking your business public there is no reason a small business should file as a corporation. Debts would advise that you instead file your company as a LLC (limited liability company).

So, what’s the difference between an LLC and a corporation? There are two main differences, first: the decision making and second: taxation.

Decision Making

Corporations have a board of directors which means there has to be a formal process in place on which decisions can be made. This can create problems as well as solve them, especially with numerous personalities thrown into the equation. Therefore, most corporations don’t have the flexibility that LLCs enjoy in terms of decision-making. The nature of a small business means it tends to lean towards an informal way of doing business, especially when it comes to making decisions.

Tax

If your business is a LLC, you will benefit from “pass-through taxation.” This is a golden nugget for LLCs looking to take advantage of the best tax benefits for businesses because pass-through taxation means the company pays no tax on its profits. So effectively, your company doesn’t even exist for federal tax purposes. What’s more, if the LLC is a sole proprietorship, the company is not required to file for tax returns. LLCs that do have more than one owner must file a federal tax return, although the LLC itself is not subject to tax.

Pass through taxation means earnings pass through to the business owners, who report the income on their own tax returns.

A corporation is not eligible for this tax benefit and instead must pay federal taxes as an entity. Shareholders are also taxed on any dividends received from the company, which in simple terms means the company’s profits are taxed twice over. However, there is an exception for companies who file under Internal Revenue Code ‘S-corp’.

Shareholders of a corporation can obtain subchapter S treatment by filing Form 2553 with the IRS within 75 days of starting operations. If this form is not filed, the corporation is taxed under subchapter C by default. Click here to download Form 2553 and file your business S-Corp

S-corp or C-corp?

S-corp and C-corp are both codes to describe a company’s tax status. The difference between S-corp and C-corp is that an S-Corp can enjoy the pass-through tax benefit just like a limited liability company (LLC) or a partnership.

A C-corp, however, is required to pay tax on income generated by the business.

While an S-corp status gives a business pass-through tax treatment, it does impose limitations. An S-corp can have only 100 shareholders, all of which must be individuals.

As a small-business owner you will probably want to choose either an LLC or an S-corp to facilitate the pass through tax treatment and to avoid the double taxation whammy of a C-corp.

What’s the difference between LLC and S-corp?

LLC members can agree to share a company’s income and shoulder its losses disproportionately, whereas S-corp shareholders must share in the company’s income in direct proportion to the number of shares they hold.

Even if an S-corp business is small and private it is still subject to corporate formalities. Such formalities include annual meetings and formal reports written to shareholders outlining matters of corporate significance eg, investment for growth. An LLC, however, does not need to get weighed down by these kinds of procedures and can operate with much more flexibility.

Debts urges proprietors of small-businesses to consult advisors on any tax benefits available to companies who file as an S-corp. A tax benefit may make suffering an S-corp’s limitations worthwhile if the tax incentive is of particular value. As mentioned above, an S-corp business is limited to 100 shareholders.

Business partnerships

We have already covered LLCs and corporations but there are two other types of partnerships to consider: a general partnership and a limited partnership.

Just to be clear, if you are the sole owner of the business you cannot call yourself a ‘partnership’ because as the name suggests, there must be more than one proprietor to make a partnership. If you are sole owner of the business, file as an LLC.

You will most often hear the term ‘partnership’ in professions such as:

• lawyers
• architects
• accountants and
• doctors.

General partnership and LLPs

Partnerships are businesses where all owners have equal managerial rights within the company – irrespective of any share holdings. While this proportionate distribution of power is often a plus within a small business, it can have its drawbacks. For instance, if one owner becomes embroiled in a lawsuit or incurs debts, all members are equally liable.

A Limited Liability Partnership (LLP) on the other hand, provides protection for individual partners within the business. If for example a doctor encounters debt problems, other doctors within the partnership cannot be held accountable.

Limited partnership and LLLP

The business structure of a limited partnership does not give all partners the right to influence business management. Limited partners, as they are known, do not get involved in the daily running of the business, that is left to general partners fulfilling a more ‘hands on’ role.

In cases where the business is liable for debts or a lawsuit, responsibility falls mainly at the feet of partners first, and then limited partners second. It is usually possible for limited partnership to obtain a LLLP (limited liability limited partnership) certificate. This certificate provides general partners with protection from lawsuits and other liabilities incurred by other business partners.

Which Business Structure is Best?

In the main, small businesses will find that an LLC is the way forward. As a business owner you will be looking for flexibility as well as liability protection. An LLC gives you both.

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