Are you thinking about starting your own business? Are you trying to determine whether to use a C-Corporation, S-Corporation, or LLC? What about a partnership? Or a DBA? Are you trying to figure out which form is best for your business?
That all depends on your situation and the type of business you want to create. C-corporations use the initials “Inc.” and are owned by their shareholders. Shareholders have limited liability, which means that they can only lose the amount of money that they invest into the corporation. If the corporation incurs a debt, the creditors cannot require the shareholders to repay the debt with their personal assets. All of the publicly traded corporations listed on stock exchanges are C-corporations. C-corporations are taxed on the profits that they make, and then are taxed again when they distribute dividends to their shareholders.
While this double taxation may be disadvantageous for some companies, for others, especially small businesses, it might actually be advantageous. The tax rate for a small C-corporation might be lower than that of its shareholder’s marginal rate, which could be as high as 39.6%. Moreover, a C-corporation can decide to distribute dividends, and thus have its shareholders pay tax on those dividends, when it is most convenient for the shareholders. This is in contrast to an S-Corporation or partnership, where taxes must be paid immediately when income is earned at the shareholders’ marginal rates. C-corporations also allow for a wide range of tax deductions not available to partnerships.
An S-corporation is like a C-corporation in most respects. Its shareholders have limited liability, and it also has a large number of tax deductions available. It differs, however, in one important respect: there is no double taxation. Shareholders are taxed only on the profits they receive from the corporation, at whatever their personal income tax rate is. There are also some restrictions on who can be the shareholder of an S-corporation that do not apply to C-corporations. For example, S-corporations can only have shareholders who are U.S. citizens or green card holders, and they cannot be corporations or partnerships.
An LLC, short for limited liability company, is a hybrid between a partnership and a corporation, and gives its “members” (they are not called shareholders, although they function the same way) significant amounts of flexibility. LLC members have limited liability. They can also elect to be taxed as a C-corporation or an S-corporation/partnership.
A partnership, unlike a C or S-corporation or an LLC, must consist of at least two “persons,” which can include corporations, natural persons, or a mixture. Partners do not have limited liability, so a creditor can come after a partner’s assets to satisfy a debt of the partnership. Partnerships are taxed like S-corporations, meaning there is no double taxation, but tax must be paid at the time it is earned at the earner’s marginal income tax rate. Partnerships do not have as many deductions available to them as C and S-corporations. Because partnerships do not have limited liability, it is generally better to use a corporation or an LLC instead of a partnership. The only partnerships which exist are in those professions in which forming corporations are forbidden, like in the legal and medical fields.
A “DBA,” which stands for “doing business as,” is a business using a different name to conduct its business activities. For example, if Coca Cola wanted to buy a new corporate headquarters, but did not want to make it obvious that it was doing so, it could purchase the property under the DBA “CC’s Property Investments.” DBAs do not change the legal structure of the corporation, so a C-corporation doing business under an assumed name would still operate as a C-corporation. Most states, including Illinois, require a company doing business under another name to file a DBA statement with the Secretary of State.
Choosing the correct legal entity is one of the most important decisions a business will make. The wrong entity could cost the business owner lots of money in extra taxes or increased liability. Business owners who are unsure of the type of legal entity to use should contact an experienced attorney for guidance.