A corporation is a legal entity that has rights similar to those of an individual, but with several important legal and tax advantages. Corporations receive their charter from a state, not the federal government. Each corporation is therefore regulated by the laws of the state where it is incorporated.
The Internal Revenue Service and federal taxation law recognizes two types of corporations for taxation purposes: a C-Corp and an S-Corp.
Most people starting a business will want to incorporate as an S-Corp. With an S-Corp, the corporation does not pay corporate taxes. Instead, the S-Corp’s profits and losses pass directly to the S-Corp’s owners (the individual shareholders), who then declare those profits or losses as part of their personal taxable income. Since most small businesses tend to lose money during the first year as a result of start-up costs, an S-Corp allows the individual to deduct those losses from their personal taxable income. Even if your business is profitable, by incorporating as an S-Corp, you avoid the “double-taxation” of paying taxes both at the corporate and shareholder levels.
A C-Corp is for larger businesses. All publicly traded corporations are C-Corps. A C-Corp has few ownership restrictions, which allows multiple investment sources. Foreign investors, companies and other legal entities are all permissible shareholders. In fact, once an S-Corp has more than 100 shareholders, a foreign investor, or a company as one of its shareholders, then the S-Corp automatically achieves C-Corp status.
A C-Corp must pay corporate taxes, similar to the income tax that an individual would pay. However, a C-Corp cannot deduct the dividends it pays to its shareholders. As a result, a “double-taxation” occurs where the profits of a C-Corp are taxed as income both at the corporate level and then at the shareholder level. If a C-Corp suffers a loss, then those losses can be offset against a future profit, but C-Corp losses cannot be claimed on an individual shareholder’s personal taxable income as they could if they were S-Corp losses.
LLC stands for “limited liability company,” which combines some of the features of a corporation with those of a partnership. Owners of an LLC are considered “members” not partners or shareholders.
Members of an LLC have the same type of limited liability protection that shareholders of a corporation possess. In other words, LLC members cannot be held personally liable for the LLC’s debts or obligations unless they have signed a personal guarantee. Unlike an S-Corp, there is no restriction on either the number of members (which is unlimited) or the kind of members (which can be individuals, corporations or other entities). Similar to an S-Corp, however, the profits and/or losses of an LLC can be passed through to individual members, thus avoiding the double taxation of a C-Corp. Unlike a corporation, which is required to have meetings, record resolutions and keep formal minutes, an LLC has no such requirements, making it simpler to operate.
If you have aspirations to take your company public, a traditional corporate structure will make for an easier transition than an LLC. Additionally, the IRS has recently taken the position that all profits of an LLC are subject to FICA and Medicare taxes. Depending on your operating agreement, it can be difficult to make changes to the existing management team or bring in additional investors.
Corporations and LLC’s, while solvent, can last forever. For an Arizona corporation, an annual report fee must be paid. To maintain your Nevada corporation, an annual list of officers and directors must be submitted with the associated fee. Nevada also requires an annual list of members and managers for a Nevada LLC.