Whether you've purchased an existing business or want to start a new one, you must first decide whether to own the business yourself (a sole proprietorship or partnership) or to form a separate legal entity—a corporation (S corporation or C corporation) or an LLC.
Each of these “business types or structures” has key advantages and disadvantages. And whichever one you choose, know that there will be more hard decisions to make. If you decide on a sole proprietorship or partnership, you will want to consider doing business under your own name or using a DBA (doing business as) name. If you want to operate as a separate entity—should it be an LLC or a corporation—you will need to find out if you qualify for any tax advantages.
Sole Proprietorship or Partnership? Consider Filing a DBA
If you are the only owner of a business, that is called a sole proprietorship. If you own it with other people, that’s what is known as a partnership.
If you choose to own the business this way, then you may want to consider filing a DBA. A DBA filing (also called an assumed or fictitious business name filing) allows a person to transact business using a name other than his or her legal name.
Sole proprietorship exampleFor sole proprietorships and general partnerships, unless a DBA is filed, the business name is the same as the owner’s name.
John Smith is operating a landscaping business as a sole proprietorship. In order to transact business as Smith’s Landscaping, he must file a DBA for that name. Otherwise, he must transact business as John Smith.
Purpose of a DBAThe main purpose of a DBA filing is for consumer protection—it informs the public as to who really owns the business. The filing generally is made at the county level, but some states require the DBA filing to be done at the state-level—or in addition to filing at the local level. In some states the filing is effective for a limited number of years and must be renewed.
Note: Corporations and LLCs that wish to do business under an assumed name are also required to make a public filing.
Advantages and limitationsThe main advantage of doing business as a sole proprietorship or partnership is that it is less expensive and easier to run than a corporation or LLC. The main disadvantage is that the business owner (or owners) are liable for the business’ debts and obligations.
C Corporations and S Corporations: Understanding the Different Types of Corporations
A corporation is a separate legal entity formed under state law. The corporation owns the business and all of its assets and properties. The shareholders own the corporation. The main advantage of incorporating is that shareholders are not liable for the business’ debts; the corporation is liable.
A corporation might be the right business type for you if you want or need:
- Venture capital for financing
- Flexible profit-sharing among owners
- Company earnings to stay in your business so that it can grow
- Flexibility to spread the business earnings between the corporation and shareholders for tax-planning purposes
- Flexibility to set salaries for employees/owners to minimize Social Security and Medicare taxes.
- Flexibility to provide (through the corporation) substantial health and medical benefits and other fringe benefit programs for things like education, life insurance, and transportation costs
- To be able to easily sell your business
- To provide an accountable plan for travel & entertainment
- To be able to offer stock options to employees
Tax differences between a C corporation and S corporationOnce you’ve incorporated your business, you have to decide whether it should be taxed for income tax purposes as a C corporation or an S corporation.
A C corporation (or C corp)—so called because it is taxed under Subchapter C of the Internal Revenue Code—is a separate taxpayer, with income and expenses taxed to the corporation. If corporate profits are then distributed to the shareholders as dividends, the shareholders must pay personal income tax on the distribution, creating “double taxation. Many small businesses do not opt for C corporation tax status because of this tax feature.
If the corporation qualifies, you can elect S corporation status by filing a form with the IRS—and with your state, if applicable—so that profits, losses and other tax items pass through the corporation to you and any other shareholders and are reported on the shareholders’ personal tax returns. The S corporation (or S corp)—so called because it is taxed under Subchapter S of the Internal Revenue Code—does not pay tax.
Not every corporation qualifies, however, to be an S corporation. There are restrictions imposed by the tax law on the number and type of shareholders and on the classes of stock, among other things.
Limited Liability Company (LLC): How LLCs They Different from Corporations?
Another business entity type that is formed under state law and gives you personal liability protection is the LLC.
An LLC gives its owners (called members) greater flexibility than a corporation in deciding how it will be managed and how financial interests will be split. Tax-wise, an LLC is similar to an S corporation because it is a pass-through entity. The business income and expenses are reported on the personal tax return of its member(s).
If you are the only member of an LLC, the LLC is viewed as a “disregarded” entity. This means you report the LLC’s income and expenses on Schedule C of Form 1040─the same schedule used by sole proprietors. If there is more than one member, the LLC is taxed like it was a partnership. An LLC can also choose to be taxed like a C corporation by filing a form with the IRS. And if it qualifies, it could also be taxed like an S corporation.
Tax differences between an LLC and a corporation (C corp and S corp)Although LLCs and S corporations are both considered pass-through entities for federal income tax purposes, they are not taxed identically for all purposes. For example, they are affected differently when it comes to employment taxes.
Tax laws are complex and change frequently. Therefore consulting with a trusted tax advisor may be necessary to decide whether a sole proprietorship (or partnership), C corporation, S corporation, or LLC is the best for your business tax-wise.
Other Considerations: State Selection
Most people opt to incorporate as a corporation or form an LLC in the state in which their business operates.
However, you are not required to do so. You can choose from any one of the 50 states or the District of Columbia (DC). You may want to consider which state is right for you by weighing any potential benefits and drawbacks.
Remember, if you incorporate as a corporation or form an LLC in a state other than the state where you operate your business, the corporation or LLC will be required to register (also known as qualify) in every state in which it will be considered transacting intrastate business. This will require paying registration and ongoing fees/taxes, filing annual reports, and appointing and maintaining a registered agent and office in both the state of formation and states of qualification.
Making Your Decision
The choice to operate your business as a sole proprietorship (or partnership) with a DBA name, or to form a corporation (taxed as a C corp or S corp) or an LLC, depends on your particular business, situation and goals.
Before making a decision, consider talking with an attorney or accountant. As you decide which business structure is best for you, try our Incorporation Wizard to compare multiple business types by multiple key considerations.