When you first dive into a new business, one of the first things you must determine is whether or not you will incorporate. There are several different types of corporations, and each has its own set of advantages and disadvantages.
What Exactly Does It Mean to Incorporate?
Basically, incorporating makes defining your business as a legal entity.
Why would a business choose to incorporate? Here are just some advantages:
- Owners of corporations are protected from liability of company obligations
- Corporations may be able to raise capital funding easier
- Corporations have legal systems that guide their owners
- They are subject to some tax benefits
Of course, with advantages come some disadvantages.
- Corporations are required to hold annual meetings
- They are more costly to set up than partnerships or sole proprietorships
- They are required to periodically file state fees
You have three choices: C Corporation, S Corporation and LLC. Let’s look at each type and who they are best for.
C Corporations
A C Corporation is owned by its shareholders. The structure of a C Corp limits each shareholder’s personal liability to the amount they invest.
Who are they best for? In general, C Corps are good for businesses who:
- Need venture capital funding
- Encourage profit sharing
- Want to be able to share the business earnings between shareholders for tax purposes
- Want the option to set employee salaries to minimize Medicare and Social Security taxes
- Want the option to easily sell the business later on
- Want to offer stock options to employees
S Corporations
An S Corporation is a corporation that has a special tax status with the IRS, which eliminates double-taxation, which may occur with a C Corp. The business files their tax return but no taxes are paid at the corporate level. Instead, the profits or losses are filed on the individual shareholders’ tax returns.
Who are they best for? S Corps are good for businesses who:
- Want prefer the benefits of a corporate business but don’t want the double taxation
- Want the option to set employee salaries to minimize Medicare and Social Security taxes
- Flexibility of choosing accrual or cash accounting
- Want a lowered risk of getting audited by the IRS
Limited Liability Companies
A LLC offers the benefits of limited liability protection, combined with the benefits of pass-through taxation. A LLC’s income will be taxes at an entity level, but they can file a partnership return if they have multiple owners. Profits and losses are passed through the business and paid on each owner’s individual reports.
Who are they best for? Businesses should consider becoming a LLC if they:
- Anticipate losses for the first few years and would like to pass those losses on to the owners
- Want flexibility in their accounting method
- Want a little more flexibility in the way their management is structured
- Want flexibility in their profit sharing plan among the owners
Like everything in business, incorporating has its advantages and disadvantages. Businesses should first determine if incorporating is for them, and then figure out which type is best for them.