LLC, S Corp, Sole Proprietorship – Does it Really Make a Difference?

The initial decisions made in starting up a business can have a significant impact as your business grows.  Starting from a proper base can allow you to customize and expand your business structure as the business expands, whereas a “quick and dirty” approach can create bigger headaches in the future for the business.  This simple guide will help the emerging business with some of the basics of the common formation options.

Sole Proprietorship – This is one of the easiest paths to set up and run a business.  You basically just run the business without any formal entity structure.  Unless you have employees, you will likely use your own social security number for financial transactions and all of the finances are reported on your own income tax return.  However, the biggest concern is that this structure does not provide you the owners with any liability protection from your business operations.  In other words, if your business gets sued, you get sued individually and your own personal assets are then exposed to the business debts and liabilities.

General Partnership – If you have one or more business partners, a partnership is another category of where your business can be classified.  The partnership will file a tax return and the net income is “passed through” to the partners.  What this means is that the partnership doesn’t pay any taxes, but the individual partners will report the income on their individual return.  However, like a sole proprietorship, the personal assets of the partners are exposed to the liabilities of the partnership. 

“C” Corporation – Compared to a partnership or a sole proprietorship, a “C” corporation protects the individual owners of the corporation from liability from the business.  In essence, it is a “corporate shield” where the liability stays within the company.  One common complaint does concern the fact that the corporation is taxed on its income, and the profit distributed to the owners is taxed again at the individual’s level creating a “double taxation” situation.

 “S” Corporation – An “S” corporation has the same corporate liability protections (corporate shield), but a special election is made with the IRS so that the “double taxation” result does not apply.  The corporation does not pay taxes, but rather the owners (shareholders) of the business report the taxable income on their own individual returns.  This option is limited to corporations with less than 100 individual shareholders.

Limited Liability Company – The limited liability company (LLC) structure is the most recent legal entity permitted by statute.  It combines some of the benefits of the corporate liability protection with some of the tax advantages of a partnership.  Because of the flexibility and “best of both worlds” result, LLC’s have been come extremely common in their use for operating a business.

In determining the type of entity, it is beneficial to get advice from your legal counsel as well as your tax advisor as a certain entity choice may be better for your particular situation.  There is no one answer for all situations.