What Are the Different Types of Business Entity Structures?

Investor Words defines a corporation as: "The most common form of business organization, and one which is chartered by a state and given many legal rights as an entity separate from its owners. This form of business is characterized by the limited liability of its owners, the issuance of shares of easily transferable stock, and existence as a going concern..."

When considering what is a corporation, the liabilities of its owners or shareholders is limited to the extent of their investment, unless they have also made personal guarantees during the course of the business. A corporation is formed in order to conduct business and to enable the company to raise funds. There are three common types of corporations, an S Corporation, C Corporation and a Limited Liability Company. While each has similarities, they also have specific differences in structure that impact legal and tax implications.

There are three basic types of corporations, S Corporations, C Corporations and Limited Liability Companies (LLC). Each of these structures offers the same similar features including:

Limited personal liability - Shareholders of S Corporations and C Corporations as well as members of a Limited Liability Company are not generally personally liable for debts of the corporation. The exception to this rule is for matters that concern personal harm, which may still be limited by law and the signing of personal guarantees.

Ongoing interest - Except in unusual cases (set out by agreement) all three types of corporate structures will continue to function in the event of the death or resignation of the original board of directors.

Raising money - Each corporation (unless limited by their articles of incorporation) may raise money from sources other than those on the board of directors. There are some restrictions placed on S Corporations (explained later) and all must adhere to standards of securities law.

Formation - Each type of corporation requires that the formation be legalized through the individual state in which the company will reside. This often involves separate state fees that must be paid, typically to the Secretary of State or a Corporation Commission.

Employees - Each entity is allowed to hire employees and pay salaries. Business deductions for all corporations must be carefully tracked for income tax purposes.

When setting up a business, it is likely that the person (or persons) involved in the inception will determine which business structure works best for them.

While there are some similarities between the various business formations, there are some differences that must be taken into consideration when deciding which business structure works best for those involved in a corporation. These differences can be significant when it comes to raising money and paying taxes.

C Corporations - C Corporations are double taxed. There is a corporate business tax and the income is passed through to owners in the form of salaries. Shareholders in a corporation are also taxed on capital gains or dividends that are paid out. C Corporations are allowed to have as many shareholders as they desire. There is no limitation on who may own shares in a C Corporation.

It is important to note that C Corporations are not obligated to sell shares. There are "Closed Corporations" which are often set up for the sole purpose of protecting copyrights and patents. These corporations have a smaller shareholder base (often family members) than public companies (for example, Microsoft is a publicly traded company with thousands of shareholders). Closed corporations are typically limited to fifty (50) shareholders and are not required to make any public disclosures nor are they required to hold annual board meetings. Some states do not allow for the formation of a closed corporations.

S Corporations - Corporations may choose an "S Corporation" designation from the Internal Revenue Service. This is accomplished by filing Form 2553. This changes the taxable structure of the corporation, allowing income to "flow through" to the owners (or shareholders) of the corporation and not be taxed at the corporate level. The ownership in an S Corporation is restricted to not more than one hundred (100) owners and may not be partially owned by any other corporation structure or any foreign persons. Trusts and estates may be allowable shareholders.

The Limited Liability Company website defines an LLC as "a relatively new business entity, at least in the United States. Its basic features are that its owners have limited liability for the entity's debts and obligations, similar to the status of shareholders in a corporation, and its income and losses are normally passed through to the owners as if it were a partnership. It is probably most like a limited partnership, without the requirement that there be at least one general partner liable for the debts and obligations of the partnership." Until 1997, only a small number of states recognized a Limited Liability Company.

Limited Liability Companies are most frequently used by professionals such as attorney's, doctor's or others who wish to enjoy the benefits of an LLC including limited liability, pass through income and not have to meet the more stringent requirements of a partnership agreement. LLCs require specific documents to be formed, with each "partner" agreeing ahead of time what the disposition of their share of the corporation will be in the event that they resign or are deceased.

Like closed corporations, LLCs are not generally held in a manner that allows anyone to invest in the corporation. Similar to an S Corporation, income passes through and is not subjected to corporate taxation. LLCs may be formed by a single person, by multiple persons and may also be held in what is commonly called "cells" where the LLC has offices in more than one state.

The Internal Revenue Service states "LLCs can only be classified as a corporation, partnership or sole proprietorship". Form 8832 must be filed with the Internal Revenue Service in order for the organization to be properly classified for tax purposes.

A Limited Liability Company does offer owners limited liability when it comes to corporate debt, unless personal guarantees are signed.

So, when considering what is a corporation--these are the three basic types of corporations that may be formed to allow a business to take advantage of tax breaks, legal protections and to protect intellectual property rights. There are other types of companies including Sole Proprietorships, DBA (doing business as), and Partnerships. Business owners must evaluate each type of business structure carefully and determine what protections best suit their individual needs. Not all corporate structures are right for all types of businesses.