Builders and Contractors Exchange
Weekly Bulletin: 14 Jun 2004
What Type Of Entity Is Right For Your Business? Part 3 of 4: Corporations
By: Richard J. Crouch
This article is the third installment in a series of four articles that explore and compare the benefits and disadvantages of different types of business entities -- sole proprietorships, partnerships, corporations, and limited liability companies ("LLC's").
In the first two articles, we discussed sole proprietorships, general partnerships ("GP's"), and limited partnerships ("LP's"). In this article, we discuss corporations.
There are two types of corporations that you should be familiar with: (i) "C" corporations ("CC's") and (ii) "S" corporations ("SC's"):
A. "C" Corporations:
1. Formation and Flexibility: CC's, which must be registered with the State Corporation Commission ("SCC"), must adhere to more formalities, because CC's are owned by stockholders who elect directors to (i) oversee the operation of the CC and (ii) elect officers who run the CC on a day-to-day basis. Many company decisions require resolutions by the directors and/or shareholders in order to be effective, and therefore record keeping for CC's is generally more cumbersome and complicated than other forms of business, such as partnerships and LLC's.
2. Personal Liability: The largest advantage of CC's is limited personal liability to the stockholders. Unlike sole proprietorships and GP's (but not LP's), the claims of creditors are limited to the assets of the CC, and stockholders cannot have their personal assets used to pay the CC's debts.
3. Taxation: When it comes to taxation, corporate income is actually taxed twice! The CC must pay corporate income tax on its earnings and later, when the CC distributes its earnings as dividends to stockholders, the stockholder must also include the dividends as personal income on its tax returns. This effect is generally unfavorable for small businesses.
B. "S" corporations:
SC's share the benefits of CC's with respect to limitation on personal liability, but differ from CC's in two critical respects: (i) Formation and Flexibility and (ii) Taxation.
1. Formation and Flexibility: Although a SC is formed like a CC, it only becomes a SC when it makes a "S election" by the timely filing an IRS Form 2553 with the tax authorities. SC's must also meet strict criteria, including, but not limited to, the following: (i) the number of employees must be 75 or fewer, (ii) there can only be one class of stock, and (iii) all of the SC's stockholders must be individuals, trusts, estates, or charitable organizations exempt from tax under Section 501(a) of the Internal Revenue Code. No stockholder can be a partnership, corporation, or nonresident alien. Such restrictions can be a significant drawback.
2. Taxation: Stockholders of a SC enjoy pass-through taxation whereby income is taxed only once as personal income to the stockholders and reported on their individual returns. Both profits and losses pass through directly to stockholders. If there are losses in the early years (or later years), these losses can be offset against the other income the individual might earn. The other benefit of SC's is that you can limit and manipulate the amount of taxes subject to payroll taxes and/or self-employment taxes. By paying employee benefits out of the SC, you get deductions but avoid paying self-employment taxes like you would in a sole proprietorship. You can also control payroll taxes to some degree by splitting income between wages and dividends, because dividends are not subject to payroll taxes.
Choosing the right entity will depend on a number of factors, and it is always a good idea to consult an attorney experienced in these matters to help you form the entity that is right for your business.
Part 4 of 4 in this series will discuss the benefits and advantages of LLC's.
Questions?
If you have any questions about this article or any other related matters, please contact:
This article is meant to bring awareness to this topic and is not intended to be used as legal advice.