What are the types of entities?
There are several types of entities you may want to consider when deciding to form your company. Each type of entity has specific tax implications, may provide different levels of liability exposure and might require a different type of record keeping. You may wish to consult an attorney or accountant to assist you in making your decision.
The following information will help get you acquainted with some of the options available:
A C corporation is a corporation taxed for income tax purposes by the Internal Revenue Services (IRS) at corporate tax rates, which may be higher than the tax rates for other types of entities. Owners take either a salary (which then necessitates the filing of quarterly and annual payroll tax filings) or dividends using after tax dollars. If no other tax status is selected by the corporation and approved by the IRS, it will by default be a C corporation. A C corporation will provide limited liability for its owners.
A C corporation allows for the easy transfer of ownership through the sale of stock and will continue to survive past the deaths of individual shareholders.
A C corporation is the most rigidly structured and organized. Complete and accurate record keeping is imperative in order to preserve the liability protection available to its owners. Each year, the shareholders must hold an annual meeting or take action by written consent (depending on the corporation’s by-laws and applicable state statutes) to ratify actions taken on behalf of the business for the previous year. A separate bank account must be maintained and there may be no co-mingling of personal and corporate funds. All assets of the corporation (such as bank accounts, automobiles, credit cards, loans) must be in the name of the corporation, although a shareholder may be asked to guarantee payment of corporate borrowing.
An LLC is more flexible than a corporation and simpler to maintain, yet still provides its members the limited liability protection available to a corporation while enjoying the pass-through tax treatment of a sole proprietorship or partnership. An LLC is run under an Operating Agreement rather than corporate by-laws.
Members of an LLC are the owners of the company, who generally report tax liability on their personal tax returns, thereby paying taxes at the lower personal rate. Members can draw funds from the LLC without the double taxation of a C corporation. The type of entity may be selected on IRS Form SS-4, Application for Employer Identification Number. In some instances, it may be necessary to fileIRS Form 8832, Entity Classification Election.
S corporation status is one afforded by the IRS. To become an S corporation, first a regular or close corporation is formed and then a Form 2553 is completed and filed with the IRS to declare S status. An S corporation is not taxed as a separate entity by the IRS, but its profits “pass through” to the individual stockholders and are taxed at each individual taxpayer’s income tax rate. Profits and losses are passed through to the stockholders’ personal income tax returns. With an S corporation, shareholders may take a “reasonable” salary as well as shareholder distributions. Payroll expenses will be assessed against a shareholder’s salary, as with any other employee.
An S corporation, despite its distinct taxing structure, provides limited liability for its owners, just as a C corporation does. As with a C corporation, complete and accurate record keeping is essential for limited liability to be protected.
A corporation selling stock to the public, having more than 100 shareholders or having more than one class of stock may not be an S corporation. A corporation considering “going public” should take these restrictions into consideration when determining whether to be a C or an S corporation at the time of formation. (For a complete listing of who may elect to be an S corporation, please review the IRS Instructions for Form 2553.)
S corporation election must generally be made within 75 days of the state filing organizing the corporation and the form must be signed by all shareholders of the corporation. Again, it is advisable to check with your attorney or tax professional with regard to the elections you make and the forms you file.
A close corporation is a regular corporation with special provisions, which may be set out in the certificate of incorporation. To be a close corporation, you must elect to be subject to these special provisions. Special provisions include (a) the requirement that the number of stockholders must be specified and cannot exceed a specific number, (b) specific restrictions on transfer of stock will apply to all stock of the company, and (c) there may be no public offing or trading of stock, within the meaning of the United States Securities Act of 1933, as amended. Shareholders in a close corporation will generally take an active part in the management of the company. A close corporation provides owners with the same limited liability protection as a regular C corporation. Good record keeping is required to maintain status as a close corporation.
A non-stock corporation (called a not-for-profit or nonprofit corporation in some states) is formed and then the appropriate application for recognition is completed and filed with the IRS. Nonprofit status is granted by the IRS. Contrary to the sound of its title, a nonprofit corporation may end its fiscal year with money or assets in hand. A nonprofit corporation is different from a regular or close corporation in that there are no stockholders to whom “profits” may be passed. When forming a non-profit corporation, it may be necessary to include language in your formation document agreeable to the IRS and pertinent to the exemption you will be requesting. Check with your attorney or accountant to determine the correct wording and exemption form or go to the IRS website for further information. Only the IRS can determine whether your corporation qualifies for tax-exempt status.
For those entities applying for exemption under Section 501(c)(3) of the Internal Revenue Code (IRC), a Form 1023, Application for Exemption, must be filed within 15 months of formation of the entity.
If you are forming a nonprofit corporation that may not be applying for tax exempt status under Section 501(c)(3) of the IRC, you may read about other 501(c) organizations at http://www.irs.gov/publications/p557/ch04.html.
Churches are automatically afforded tax exempt status and are not required to file a Form 1023 or annual tax return.
Homeowner associations are not considered nonprofit corporations by the IRS and are required to file a Form 1120-H with the IRS.
If you wish to form a not-for-profit corporation, we suggest you contact your attorney or tax professional to be sure all the requirements of the IRS are met. Once you have done this, please contact us at firstname.lastname@example.org if you require our assistance filing the formation document approved by your attorney or tax professional.
Professionals may consider forming a professional corporation. With a professional corporation, the entity is subject to the same general statutory provisions as a regular corporation and the professionals are afforded the limited liability of a regular corporation. Requirements may differ by state but it is usually necessary for those persons forming a PC to show proof of professional license. Those not members of the applicable profession will not be allowed to be stockholders in and officers and directors of the PC.
When two or more persons will be co-owners of a business, they may choose to form a general partnership. Typically, all of the partners of a general partnership are equally liable for the debts of the partnership and the actions of the other partners. While a general partnership should include the drafting of a partnership agreement, such agreements are not always filed with the applicable secretary of state’s office. To have a partnership where the partners are afforded protection from the debts of the partnership, an LLP may be formed. A statement of qualification will be filed with the appropriate secretary of state’s office indicating the partners wish to have their partnership classified as an LLP. Many LLPs are formed by professional persons such as lawyers, doctors or accountants who, historically, participated in general partnerships.
A benefit corporation, also known as a “B corp” or “Public Benefit Corporation” is a for profit corporation where the profitability of the corporation isn’t always the primary goal, as is the expectation of traditional for profit corporations. The goal or purpose of a benefit corporation can and must include a benefit to others whether they are people or public interest. When managing a benefit corporation, all of these considerations, both for the shareholders and the public which is affected by the actions and activities of the corporation, are balanced. Click here to find out more information.
Note: Each jurisdiction treats benefit corporations differently. Please contact us for assistance.