How to Pick the Right Corporate Structure

Written by Dianne Molvig Wednesday, May 26 2010

Perhaps you’re launching a new business. Or maybe you’ve been operating for some time as a sole proprietorship or partnership. Whatever your situation, you’ve decided the time is right to create a formal legal structure for your business.

You have three options: a limited liability company (LLC), S corporation, or C corporation. The latter two refer to subchapters S and C of the Internal Revenue Code.

All three entities offer you a key advantage over less formal structures: protection from personal liability. That means if your company can’t pay its debts or gets sued, the company is liable, not you personally. You won’t end up paying the debts or damages out of your own pocket.

While liability protection is the common thread, these three types of business entities also have significant differences. The right choice for you depends on the nature of your business, its finances, your tax situation, and other factors.

Of the three forms, “The LLC has the least amount of formalities and offers the most flexibility,” says Lia Moeser, a Milwaukee business attorney. “It’s perhaps the most popular form of business entity used today.”

Unlike LLCs, corporations have many required formalities, such as electing a board of directors, writing bylaws, issuing stock, holding annual meetings, keeping corporate minutes, and publishing annual reports. LLCs face less onerous paperwork and record-keeping requirements.

An LLC also has few restrictions on who can be owners, referred to as members. In many states, a single individual could make up an LLC. Or corporations could be members in an LLC.

An LLC is “extremely flexible,” says Lori Conaty, a certified public accountant in Warwick, R.I. “For instance, an LLC doesn’t have to have equal ownership among members or equal sharing of profit or loss.”

An S corporation has limitations, in all states, on the number and types of owners. “It can have no more than 100 owners,” Moeser says, “and only residents and U.S. citizens are permitted to be shareholders. Partnerships and other corporations can’t be owners of an S corporation.”

Taxation also differs among the three business entities. Both the S corporation and LLC have pass-through taxation. In other words, the company’s profits, losses, credits, and deductions pass through to the owners’ personal tax returns.

But there’s one area that may tilt some business owners toward an S corporation instead of an LLC. That relates to the self-employment tax that covers Social Security and Medicare taxes.