Incorporation offers small businesses one main advantage: protection of owners' personal assets from legal liability. Here is a look at the advantages and disadvantages of the three different ways of incorporating a business.
This is the most common type of corporate entity.
Pros: A C corporation is ideal for a business trying to attract public acquisition and venture capital. A C corporation can have an unlimited number of shareholders. Also, "there is still the mind-set among some investors that they're looking for a C corp as a more professional-level entity," says Deborah Sweeney, an incorporation expert at Intuit.
Cons: C corps have to abide by many formal requirements, such as holding meetings of a board of directors and keeping minutes, maintaining corporate bylaws, and filing formal paperwork. Also, C corps are taxed as a separate corporate entity, so in addition to your personal income taxes, you will have to pay corporate taxes.
Limited liability company
A relatively new entity, LLCs have only in recent years become available in all states. Profits are distributed as the members of an LLC see fit, instead of based on ownership as in a C corp.
Pros: An LLC lacks the formalized requirements of a C corp but has the same liability protection. In an LLC, you are taxed on your personal income only, so you don't have to worry about being taxed at the corporate level. Finally, there is no limit on the number of LLC members, and anyone can be an owner, including non-U.S. citizens.
Cons: LLCs cannot go public or issue stock, and they may have to pay self-employment taxes.
This has elements of both an LLC and a C corp. As with a C corp, profits are allocated based on ownership. If a C corp is electing to become an S corp, that move this year has a March 17 deadline (usually March 15 when it is a weekday) for businesses operating on a calendar year.
Pros: As with LLCs, the partners of an S corp are taxed on their personal income only.
Cons: S corps have many of the formal requirements of a C corp. Also, they are limited to 100 shareholders, and all shareholders must be U.S. citizens.