Choosing a Business Tax Structure: Types of Corporations and LLC’s

Many of us may have seen phrases like “LLC” and “sole proprietorship” in passing all our lives but didn’t really look into them to discover what they mean. If you are opening a new small business in Michigan, however, it’s important that you do understand the differences between the various types of entity options before choosing a business tax structure and the types of corporations and LLC’s out there. It will most certainly impact your taxes, your finances, and possibly even the profitability and vitality of your small business in the future.

Following are a few of the basics regarding C corporations, S corporations, LLCs, partnerships, and sole proprietorships that dentists, veterinarians, and other small business owners should know before they open their new business.

Choosing a Business Tax Structure – What is a C Corporations?

The C corporation is the standard corporation structure under IRS rules. It is named for Subchapter C in the Internal Revenue code. McDonald’s, Starbucks, and Apple are all examples of C corporations.

A C corporation is a legal structure for a corporation in which the owners or shareholders are taxed separately from the entity. C corporations are the most prevalent of corporations, and they are subject to corporate income taxation. The taxing of profits from the business is at both corporate and personal levels, creating a double taxation situation. A C corporation is a limited liability entity; the company, not its shareholders or owners, is legally liable for the company’s debt and other obligations.

What is an S Corporation?

The “S” in S corporation stands for “Subchapter S” in the Internal Revenue code. It may also be identified as “Small Business Corporation.” 

This special tax status granted by the IRS allows these corporations to pass their corporate income, credits, losses, and deductions through to their shareholders for federal tax purposes. Shareholders must be an individual, tax-exempt entity, estate, or trust. Shareholders then report the income and losses on their personal tax returns, and they are assessed tax at their individual income tax rates. This allows S corporations to avoid double taxation on the corporate income. 

To qualify for S corporation status, the corporation must be a domestic corporation that has shareholders, but not more than 100 shareholders. An S corporation should have only one class of stock, and some types of corporations are not eligible, such as financial institutions and insurance companies.

What is a Limited Liability Company (LLC)?

As defined by the IRS, a limited liability corporation (LLC) is an entity formed under state law by filing articles of organization. Generally, for income tax purposes, a single-member LLC is disregarded as an entity separate from its owner; income and deductions are reported on its owner’s federal income tax return.

What Does Sole Proprietorship Mean in Business?

A sole proprietor is someone who owns an unincorporated business by himself or herself. You are also a sole proprietor for income tax purposes if you are an individual and the sole member of a domestic LLC unless you elect to have the LLC treated as a corporation.

Under what Circumstances Should a Small Business Identify Itself as a Partnership?

A partnership is a formal arrangement by two or more parties to manage and operate a business and share its profits. 

There are several different types of partnerships. In some situations, partners share liabilities and profits equally; in others, partners may have limited liability. In some cases, a silent partner may be involved as well, which means this person or entity is involved financially but not in the day-to-day operations of the business. 

Professionals that frequently form limited liability partnerships include doctors and lawyers. A partnership may gain more tax benefits than a corporation.

When is the Phrase “Independent Contractor” Appropriate?

Accountants, lawyers, veterinarians, ride-share drivers, and dentists are among those who are generally considered independent contractors. It’s a one-owner business, and this independent contractor is the person who pays for the work and has the right to control or direct the result of the work. That individual’s earnings are subject to a self-employment tax.

Most independent contractors are sole proprietors, but many independent contractors are choosing to form single-member limited liability companies in order to create a more formal business structure.

The above is a very broad overview of some types of organizations as well as pertinent terminologies, but there are many more. Once you understand the various types of corporations and what they mean, you will have to decide which format makes the most sense for you legally, financially, for the sustainability of your business, and for your greatest peace of mind.

Contact one of our business accountants here in Wayne County, Michigan, to learn more about the various types of small business corporations. We can answer your questions, serve as your Michigan business’s accounting firm, or point you toward legal professionals who can further assist you in getting your startup underway.