Sole Proprietorships and Partnerships
Sole Proprietorships and Partnerships are great for getting started quickly and with minimal cost for startup, however you need to be aware that you have unlimited liability for business debts. So if your business is sued for any reason, the plaintiff will be able to come after your business assets and your personal assets, including your home.
LLCs provide protection to your personal assets and they do offer significant flexibility if you are looking for more elaborate allocation and distribution schemes with preferential returns for founders and investors.
However, there are no tax advantages to forming an LLC. In fact, forming an LLC won’t change a thing for federal income tax purposes. Single-owner LLCs are taxed just like sole proprietorships, and multiple-owner LLCs are taxed just like partnerships, and in California LLCs are subject to an additional franchise tax based on their gross revenue, as well as income tax.
An LLC can elect to be treated as a corporation for tax purposes.
S-Corporations provide protection to your personal assets and provide pass through taxation directly to shareholders without dreaded double taxation arising from the payment of dividends. Therefore you’re allowed to distribute any profits, after you pay any owner-employees a “reasonable salary”, which will be subject to Social Security and Medicare taxes.
S-Corporations are however restricted to one class of stock and foreign ownership of shares is prohibited.
C-Corporations provide protection to your personal assets and unlike most other business structures, are themselves taxable entities. This means that the C-Corporation itself is taxed on its income, as opposed to other structures, which simply pass through income to the owner(s). Investors prefer C-Corporations since they allow for different classes of stock.
If you don’t plan to distribute all of the profits from your business, you might benefit from forming a C-Corporation and splitting the business’s income so that part of it is taxable to the C-Corporation and part of it is taxable to the corporation’s owner(s).
The big disadvantage to C-Corporation taxation is that distributions of profits through dividends are subject to double taxation, which means that the C-Corporation is taxed once on its income, and then the shareholders are taxed again on any dividends.
These business structure options should be analyzed against your personal goals in order to determine what is right for you. There is no one size fits all solution to this question but the professionals at Mathews Law Office are here to help navigate these options in order to help you make the right choice for you.
This Article is by no means meant to be a complete analysis of all the pros and cons of the above described business structures nor is it an endorsement of one business structure over another.