Legal Structures for Business
T
here are several different types of business entities when discussing legal structures for a business. There are five (5) different types of business structures that will be discussed in this article. These five (5) business structures are the following: • C Corporation • S Corporation • Professional Corporation (PC) • Limited Liability Corporation (LLC) • Limited Liability Partnership (LLP)
C CORPORATION A C corporation is a fictional entity that is created under state law to be separate and distinct from the business owner(s). Each State has separate laws which govern the creation of Corporations in their state. There are two (2) characteristics that describe a C corporation. Simply put, a C corporation is a business entity that does not elect to be treated as a small business. There will be a quick overview of a C corporation because it is not commonly used by small businesses. 1. Limited Liability Protection A C corporation has limited liability protection, which means that its’ owners and the C corporation are separate from one another. Generally, a C corporation is only liable for the debts that it incurs and the owners of the C corporation may not be sued for the debts of the C corporation. As an experienced attorney, there are many exceptions to the general rule: if one does not maintain sufficient capital, operate their business like a business, and follow the formalities as established under the Business Corporation Act of 1983, 805 ILCS 5/. 2. Taxation One disadvantage of a C corporation is double taxation, which means that the business entity is taxed on its’ business income and its’ shareholders are taxed on any distributions made to them.
12
These shareholder distributions are taxed as dividends or capital gains. Most small businesses do not operate as a C corporation because of double taxation. Generally, small business owners may want to consider a C corporation if they want to offer a generous healthcare plan and want a business deduction. In most cases, small business owners will elect to be treated as an S corporation.
S EAN L. R OBERTSON , R OBERTSON L AW G ROUP, LLC
1. Limited Liability Protection Similar to a C corporation, an S corporation has limited liability protection for its owners, which is separate and distinct from them. Again, one must follow proper corporate procedures to be eligible for limited liability protection such as maintaining good corporate records, no commingling of personal and business funds, and adequate capitalization.
S CORPORATION According to the Internal Revenue Service (IRS), S corporations are corporations that elect to pass income, losses, and deductions down to the individual shareholders on their personal tax returns and to be taxed at their individual income tax rates. Simply put, small business owners use S corporations to avoid the double taxation of C corporations. There are special rules that govern the election of an S corporation. Generally, an S corporation must be a U.S. Citizen or Resident of the U.S; have no more than one hundred (100) shareholders; have one class of stock; and not be an ineligible corporation such as certain financial institutions, insurance companies, and domestic international sales corporations. Generally, an S corporation must be owned by a U.S. citizen or a Resident of the United States. Thus, if your client is not a resident or U.S. citizen, an S corporation is inapplicable to them. Second, an S corporation may not have greater than 100 individual shareholders. Third, an S corporation must only have one class of stock. For instance, owners of the S corporation may not have voting and non-voting stock. Thus, all of the shares of the S corporation must be voting shares of stock. Fourth, there are some corporations that are highly regulated and are not allowed to be an S corporation. To qualify for S corporation election, a Form 2553 “Election by a Small Business Corporation” must be filled out and signed by all shareholders.
2. Taxation An S corporation is considered a “pass through entity”, which means that its’ individual shareholders pay federal and state taxes based upon their profits, losses, and deductions and their particular tax scenario. Simply put, this means that the S corporation will not pay tax. Instead, the S corporation will only provide an informational return and the individual shareholders will assume the tax liability as individuals. Unlike a C Corporation, an S corporation does not pay taxes at the shareholder and employee level. Most small business owners generally are S corporations or Limited Liability Corporations. 3. Formal Corporate Structure One of the requirements of an S corporation is only one class of stock. One of the drawbacks of an S corporation is the rigidity of its requirements. In contrasts, a Limited Liability Corporation is a hybrid between a partnership and a Corporation. The formality of the structure becomes a big deal when a business owner desires to have multiple owners and investors. In business, shareholders and business entities have different goals and obstacles and, sometimes, the rigid structure of an S corporation does not allow for the S corporation to favor or customize its structure to the particular goals or circumstances of its shareholders. For example, John, Adam, and Sue start up a shoe business and Sue will only be investing $35,000 into the STARTING AND GROWING YOUR BUSINESS