Part Two: Choosing the Right Entity for Your Business - Corporations & the LLC

In this final part to our brief discussion of business structures, we will introduce various types of corporations as well as the limited liability company and the tax, liability and general considerations for each.

Corporations

Standard Corporation

A corporation is a business entity that is legally distinct from the individuals or entities that own it. A corporation, in contrast to the partnership structures covered in Part 1: Choosing the Right Entity for Your Business, will continue to exist even if the owners of the corporation die. Also, because the corporation is independent from its owners, a corporation can pay taxes, has the right to enter into contracts and can own assets. The owners of the corporation are shareholders, the corporation’s policies are generally set by its board of directors and day-to-day operations are managed by the corporation’s officers. Shareholders are generally shielded from personal liability for the corporation’s debts, lawsuits and other obligations.

At the federal level, every corporation is classified by default as a C corporation. C corporations are taxed as separate legal entities and are liable for federal income taxes as well as employment taxes. Of note, the dividends paid out by a corporation to its shareholders may be subject to double taxation because corporations pay taxes on profits and then shareholders pay taxes on dividends. To avoid double taxation, however, a corporation can elect to be taxed as an S corporation. S corporations are taxed as pass-through entities whereby profits and losses pass through to individuals’ personal tax returns. They are not taxed at the corporate level.

Additionally, C corporations and S corporations have different constraints. C corporations can have an unlimited number of shareholders and may be foreign owned. In contrast, S corporations cannot have more than 100 shareholders, the shareholders must be individuals and cannot be business entities, and they must be U.S. based.

Also of note, for owners who pay themselves a salary, electing S corporation tax status may offer savings on self-employment taxes. However, the salary that owners pay themselves before taking a distribution must be reasonable. If the salary is too low, thereby avoiding payroll taxes, the Internal Revenue Service (“IRS”) can reclassify distributions as wages and ultimately issue back taxes as well as penalties.

Professional Corporation

Professional corporations can generally only be owned by licensed individuals in certain professions, such as accountants, doctors, engineers and lawyers. A professional corporation offers its owners the same protection against personal liability for business debts that a standard corporation offers its owners. However, a professional corporation also shields its owners from liability for their partners’ malpractice or negligence. Business owners , however, remain liable for their own professional mistakes. Also, similarly to standard corporations, professional corporations can be taxed as C corporations or elect to be taxed as S corporations.

Nonprofit Corporation

A nonprofit corporation is usually created for charitable, educational or religious purposes. It is not designed to generate profit for shareholders, and it must use all its revenue in support of its mission.

Additionally, nonprofits receive 501(c)(3) tax exempt status under the Internal Revenue Code. In order to secure tax-exempt status after incorporation, the entity must first apply to the IRS for an Employer Identification Number and then submit an IRS form as an application for tax-exemption. There are several different IRS forms that a nonprofit could submit to receive tax-exempt status and the one that an entity should submit is determined by the type of nonprofit organization and projected gross receipts of the nonprofit.

Lastly, nonprofits generally shield their members, officers and directors from personal liability for corporate debt. However, an individual could be held personally liable for specific acts committed in connection with the business, such as those involving gross negligence, use of nonprofit assets for personal benefit and failing to pay employee withholding or payroll taxes. 

Limited Liability Company

A limited liability company (“LLC”), like a corporation, is a legally distinct entity from its owners. The owners of an LLC are called members and members’ personal assets are shielded from liability for business debts, lawsuits and other obligations similarly to the way in which shareholders’ personal assets are shielded in a corporation. Generally, LLC members are only responsible for business debts up to the amount of their contribution to the business.

Additionally, LLCs can be solely owned by one person or entity, which are known as single-member LLCs, or by multiple people or entities, which are known as multi-member LLCs. The management structure of LLCs varies but companies are commonly operated by either one or multiple members or a designated manager. The management structure of an LLC should be determined by the operational needs of the company and desired liability protection for its members, and should be discussed with legal counsel during an initial consultation with Gordon LLP.

With respect to taxation, single-member LLCs are, by default, considered disregarded entities that are subject to pass-through taxation. Multi-member LLCs are generally taxed as partnerships, whereby each member pays personal income tax and self-employment tax on their share of profits. However, LLCs can elect alternative tax treatment. The business may elect to be taxed as a C corporation, in which case the LLC would generally pay corporate income taxes at the state level and then a flat federal corporate tax of 21%. Alternatively, an LLC may elect to be taxed as an S corporation, which may reduce the members’ overall self-employment tax liability.