Types of Business Entities

There are several different types of business structures. Although it is not necessary to use a lawyer or an accountant when incorporating, American Incorporators recommends that you consult with either your lawyer or tax advisor to give you insight on choosing the most appropiate entity type for your own business. 

To help you to determine which business structure may be best for you, take our short "What Entity Type Should I be? tutorial". Or, you can also compare the most common forms of business types using our Business Type Comparison Chart.

Sole Proprietorship (SP)

A sole proprietorship, sometimes called a dba ("doing business as") or an assumed name company, is an alter ego for an individual. You might file the paperwork for this business in your city, county or state, but this is not a corporation, LLC or partnership.

More importantly, a sole proprietorship is not a "legal person" and doesn't give you any liability protection from creditors. If your company owes a debt, you personally remain liable for it. If your company is sued, your personal assets are at risk.

There's nothing wrong with starting your business as a sole proprietorship, testing the market and seeing what happens. But this does not give you either the limited liability of the business entities described below nor does it give you the business status of a corporation, LLC or partnership. A sole proprietorship may have a harder time opening a bank account, deducting business expenses, getting credit and doing business in general, and it simply won't get the same respect and credibility most people give to more formal business structures.

Limited Liability Company (LLC)

Limited Liability Companies (LLCs) are a type of business entity fast gaining popularity with small business owners engaged in a wide variety of activities. An LLC is a legal entity separate and distinct from its owners, who are called "members." An LLC is a hybrid between a corporation, which has shareholders, and partnerships, in which the partners own the company but don't have shares. In an LLC, the owners of the company receive units, not shares, and the rights, duties and obligations of LLC members are governed by an "operating agreement." You can compare an operating agreement to the bylaws of a corporation, and you can also view an operating agreement as a type of contract between the members who own the LLC.

The management of an LLC is structured with managers, who may be but don't have to be members. If a member is also a manager, he or she is called a member-manager. LLCs' operations are controlled either by the members, or member-managers.

The provisions of an operating agreement are extremely important as they can have a direct impact on how both the LLC and its member-owners are taxed for federal income tax purposes. In addition to tax matters, an operating agreement typically deals with issues of management of the LLC by either members or non-members, transfer of interests in an LLC and termination of the LLC.

When properly structured under applicable state statutes, LLC members have the same limited liability protection that is given to stockholders in "C" or "S" corporations. This means that, unless someone makes a specific personal guarantee, the amount at risk for members of an LLC is limited to their investment in the LLC. This means that the personal assets of members are generally beyond the reach of the creditors of the business. All members of an LLC get this liability protection, unlike partners in a partnership, which must have at least one general partner who remains liable for partnership debts. And unlike limited partners of a limited partnership, LLC members may be active in the management of the LLC without risking their limited liability status.

LLC members may also enjoy the same flow-through tax benefits that are applicable to partners of a partnership. Unlike a C corporation, no losses can be carried forward into future tax years and an LLC cannot keep retained earnings, meaning that it must distribute the profits or losses to its members every tax year.

Some people like to compare LLCs to S-corporations, which you'll read more about below.An S-corporation also provides limited liability protection to its investors as well as flow-through tax treatment. Nevertheless, there are distinct differences. To begin, there is more flexibility in an LLC than in an S-corporation. For example, members of an LLC may include any number of individuals, partnerships, corporations, trusts, and nonresident aliens. This is not the case with S-Corporations, which may only be owned by individuals and certain trusts and estates, and which limit the number of shareholders to no more than 100. Moreover, S-corporations have "one class of stock" restrictions. In addition, all distributions and allocations must be the same for each share. If an S-corporation violates any of these rules, it loses its status and becomes subject to taxes and other treatment as a C corporation. LLCs may (and typically do) base distributions and allocations on the basis of member contributions, rather than on a per capita basis. For information and costs to set-up a Limited Liabilty Company click here.

C Corporation

Although the most formal corporate structure, a general business corporation is the most widely used by both small and large businesses and offers the fewest restrictions. A general business corporation may have an unlimited number of stockholders/owners whose personal assets are generally protected in the event of a lawsuit against the corporation or if the business fails. A stockholder's liability is usually limited to the amount of investment in the business and no more. C corporations may also retain earnings for future investments or spending and may also carry forward into future years losses that may be deducted against future profits.

Also important is the ability of a C corporation to issue dividends to its shareholders, which may result in capital gains taxes for the shareholders, typically at a lower tax rate than ordinary income is taxed. For information and costs to set-up a C Corporation click here.

S Corporation

Many business owners find the S-corporation attractive because all earnings or losses are passed directly through to their personal income tax return. This avoids the double taxation aspect of a general business corporation. There are, however, certain requirements that must be met to qualify for S-corporation status. We recommend that you consult with your lawyer or tax advisor when considering using this type of business structure. To obtain the S-corporation tax status, all shareholders of the corporation must elect S status, by signing IRS Form 2553, and file it with the IRS within 75 days of the date of first doing business. American Incorporators can assist you with this filing. For information and costs to set-up an S corporation click here.

Non-Profit Corporation

A non-profit corporation is designed for businesses engaged in charitable, religious, educational or scientific activities that benefit society in general. The net income of non-profit corporations must be used to further the not-for-profit goals of the corporation, not to enrich individual officers, members or directors. Most non-profit corporations have either tax-exempt or 501(c)(3) status, which exempts them from paying federal taxes on their income. To get either of these tax designations, an Application for Recognition must be filed by the client (or his or her attorney) with the IRS and be approved by the IRS.

We will prepare and file incorporation documents non-profit corporations; however, the states in which we can provide this service is limited due to the complexities and special requirements imposed in many states. For information and costs to set-up a Non-Profit Corporation in those states click here.

If you are ready to form your own corporation or Limited Liability Company, you can start the process by filling out our secure online order form, or you can call one of our incorporation specialists at: 866-421-8416, and place your order over the phone.