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There’s a certain spirit about entrepreneurs that sets them apart from other business professionals. They have a creative spark and imagination that allows them to envision a new product, innovative service offering, and the market it will best serve. They are able see all the variables coming together like puzzle pieces interlocking to form a complete picture. Similarly, when entering a new venture there are many issues to consider including financing, production processes, facilities acquisition, and marketing. It’s no surprise that the choice of entity selection often falls near the bottom of the priority list, but it’s an essential exercise that must be given careful consideration because it will impact how the company and its owners are taxed. The challenge is understanding which is optimal for your situation. Here we look at the types and benefits of each option that may prove helpful in the decision-making process.

S-Corporations

This entity structure is created by filing Articles of Incorporation with your Secretary of State usually completed with the assistance of an attorney. Since it’s a company, there are shares of stock issued amongst the shareholders and various individuals that serve as directors and officers. This entity structure protects the shareholders from legal liability by protecting shareholder’s personal assets such as bank accounts from being taken to satisfy business obligations. It’s important to note this entity type is considered a “pass-through” entity which means the company doesn’t pay any federal income tax on profits earned, but rather the income tax is passed through to each shareholder’s individual return. The drawbacks to a S-Corporation are the formation and administrative expenses, stock ownership restrictions, limit on the number and type of shareholders, and the need to tax fringe benefits.

C-Corporations

This entity structure is like S-Corporations in many ways including the establishment process; presence of shareholders, directors, and officers; and the legal protection of personal assets to satisfy business debts. There are many advantages to using this entity structure such as deductible business expenses and no limit on the number and type of shareholders. Drawbacks include cost of formation and administration, possibility of double taxation as profits are taxed both on corporate and shareholders tax returns, and limitation on the ability to deduct business losses.

Limited Liability Company (LLC)

This entity structure is created by filing Articles of Organization and an Operating Agreement to define how the company will operate. Like S-Corporations and C-Corporations, LLCs offer legal protection of personal assets to satisfy business debts and obligations (but does require clear separation between business and personal finances). What makes LLCs attractive to many is the opportunity to determine how they want to be taxed including Single Member LLC, Partners in LLC, or LLC Filing as Corporation. Each type offers various benefits and drawbacks determined by the specific set up and needs of the company. The drawbacks to LLCs are they can be subject to self-employment tax, lack formal titles such as officer and directors which can lead to confusion about roles and responsibilities, and have a limited life. In many states, it’s a common requirement that when one member of the LLC departs then it must be dissolved and recreated.

Limited Liability Partnerships (LLPs)

This entity type is created by establishing Limited Liability Partnership Agreements and satisfying other filing requirements as mandated by your state. There is legal protection as partners are shielded from the possibility of having their personal assets taken to satisfy business debts. It also provides protection from the wrongful action of other partners but holds them accountable for their own liabilities. The LLP is a pass-through entity like a S-Corporation as the partnership pays no federal taxes, but the income passes through to each partner’s individual tax return. There are several drawbacks to LLPs including the limitation by some states that partners need to be licensed in the specific field where the partnership provides services (i.e. CPA, attorney, architect, or engineer).

Contact Us

There are many variables to consider when determining the correct entity type for your business including tax structure, cost of administration, and level of legal liability. The information provided above focused mainly on tax liability, but it’s important to make your final decision based on all three criteria. If you have questions about choice of entity selection or need assistance with an accounting, tax or other issue, Selden Fox can help. For additional information please call us at 630.654.1400 or click here to contact us. We look forward to speaking with you soon.

Daniel J. DiMario, JD, MST, EA

Dan's practice covers the preparation and review of business, fiduciary and individual tax returns, including returns for family offices and high-net-worth individuals. He regularly communicates with clients on changes in federal, state and local income tax laws and compliance issues, and details how these changes will impact clients’ income tax liability.