Here is a summary of the entities most commonly used in business. There are actually something like 30 entities people can operate businesses in. These are five are commonly used.
1-Schedule C self-employed with no credit protection. Owners can be sued individually.
2-Partnership with no credit protection. Owners can be sued individually. Those have been around since the time of Christ.
3-Corporation with limited liability. Widely known as a C corp because it‘s taxed according to Chapter C of the Internal Revenue code. Owners cannot be sued for unpaid business costs. This came on the scene in 1700 when investors had a need for liability limits to raise large amounts of money. The initial purpose was to create the East India Company that governed India & half of China for two centuries. This was by far the biggest & most profitable economic enterprise ever. The corporation is the only entity that pays income tax directly to the government.
3-S Corporation with limited Liability. A C corporation which elects to be taxed as a flow though organization that pushes out profits & losses to be reported on the owner’s tax returns. Commonly known as an S corp. Taxed under subchapter S of the Internal Revenue Code. Profits & losses flow through to the owners and are reported on their tax personal tax returns. That’s why you will sometimes hear the terminology “flow through companies” for entities that don’t pay tax directly to the government. Corporations & LLC’s commonly elect to be taxed as an S corp. This does not affect their legal protection. S corps are limited to 100 owners. That’s why all the big companies such as General Motors and Amazon are C corps. After 300 years all states have come to agreement on how to tax corporations & S corporations.
4-LLC with limited liability. This came on the scene in 1971. Owners cannot be sued individually as long as there are two or more owners. There is still disagreement on how LLC’s should be taxed by states. Wyoming created the LLC in 1977 to satisfy a demand for a partnership with limited liability. It has the same structure as a partnership and files taxes on the same tax return, but it has limited liability as long as there are two or more members. Owners are referred to as partners in a partnership, & as members in an LLC. LLC’s commonly elect to be taxed as an S corporation. It is a toss-up whether S corp’s or an LLC’s are the most popular business form in the U.S.
5-C Corporations with limited liability. Corporations have been around since 1700 and the law is basically settled. In every state corporations are treated essentially identically. LLC’s are relatively new (50 years) and the states have not yet come to agreement how they will be treated. In some states they are treated well, and in other states they are not a good alternative. We create most new LLC’s under WY law, South Dakota or Nevada because those state have charging orders that make an LLC almost bullet proof against lawsuit or collection activity of any kind. Nevada also has charging orders for corporations.
For most small businesses an S corp or an LLC with an election to be taxed as an S corp are the best entities. Each of these four entities are subject to different tax treatment and can deduct different expenses on their tax returns.
The state you organize is also extremely important. Wyoming, Nevada & South Dakota are probably the three best states to organize in, but the type of entity also plays a determining role in the selection. Also, there is kind of a civil war among states competing for being the Delaware for pirvately owned businesses. Every year someone drops a delightful goodie in our lap. But, remember this … you should never just organize in the state where you are located. But, as you can tell, that’s a post for another time.
A significant part of our practice is determining the proper combination to use to incur the least amount of tax.