The decision of how to incorporate when beginning a new business venture is one that can set you up for success or frustration out of the gate. You may create unforeseen problems if the choice is made without careful consideration of the differences between the various business types and their respective strengths and obligations. Limited liability corporations (LLCs) have significant advantages in taxation flexibility, depending on factors in the individual business that is considering incorporating.
When incorporating as an LLC, a business is free to elect how they will be classified for tax purposes. They may choose to be taxed as a sole proprietorship, a partnership, an S-corporation (S-corp), or as a C-corporation (C-corp).
A C-corp is rarely the preferred option for a new business. C-corp’s are obligated to pay income tax on their profits, while shareholders are also required to pay personal income tax on any profits they earn through dividends as shareholders. This is often referred to as “double taxation.”
An S-corp is not saddled with the same double taxation obligation. The profits in a given fiscal year pass directly through to an S-corp’s shareholders, who are each required to pay personal income tax on their respective profits. There are some specific restrictions for when an LLC may elect to be taxed as an S-corp. Qualified legal counsel can help determine if it is the right time to incorporate as an S-corp or any other variety of corporation
An LLC just starting out may choose to be recognized as a sole proprietorship or partnership also. These simple tax structures are easier to operate for a new business, but are required to report their business income on the personal income tax returns of their owner or owners. When a business begins to become significantly profitable, electing to be considered a different form of corporation can mean serious savings.