There’s something very powerful about starting a new business. It’s a commitment to make something from nothing and the desire to create products and services your customers love.

If you want to run a successful business, you need to build it on a strong foundation. That means deciding on the right structure and legal entity for your new venture.

The right legal structure will decide a great deal about your business — how you’re taxed, how you’re treated by regulators, how customers view you, and all the compliance and legalities you need to meet — and it can be confusing for any entrepreneur.

At Incfile, we’re experts in online business formation, and we’ve put together a guide to help you understand everything about choosing the right business entity and forming your business.

Why should I bother with forming a business?

Legally forming a business is a vital first step in bringing your products and services to market. Formally setting up your business as an LLC, S Corporation, or C Corporation means it becomes a separate legal entity in the eyes of the law, the Internal Revenue Service, and others.

That’s important because it protects your personal assets, helps you better manage finances, enables you to grow, and can be advantageous for tax purposes. It also demonstrates to your customers that you take your business seriously, which can help to build trust and win business.

Not to mention, forming a business doesn’t have to be difficult — you can complete all the steps necessary to create an LLC in under an hour, and the business could be formally created and registered in fewer than two weeks.

What types of business entities can I create?

There are several different types of business entities, including:

• Sole proprietorship: A sole proprietorship is where you do business under your own name. Your expenses and those of your business are intermingled, and there is no separation between the business and yourself.

• Partnership: A partnership is a special type of business entity where several individuals decide to go into partnership together.

• Limited Liability Company (LLC): An LLC is a common type of business entity that’s best for smaller businesses. It provides asset protection and separate financial accounts.

• S Corporation: An S Corporation is a business entity that provides tax advantages to its owners. LLCs often choose to file as an S Corporation to save taxes.

• C Corporation: A C Corporation is a business entity best suited to large and public organizations.

• Nonprofit: A nonprofit is a special type of business entity designed for charities and other organizations that do not generate profit for their owners, members, or other stakeholders.

We don’t generally recommend sole proprietorships or partnerships as they don’t give you all the protections you might want as a modern business.

In this guide, we’ll explore the most common types of business entities — LLCs, S Corporations, and C Corporations — explore the differences between them, and help you decide which one is right for your business needs.

LLC vs. Corporation: Which is best for me?

This is one of the questions we’re asked most often, and the answer is… it depends. Both LLCs and corporations have advantages and disadvantages, and we’ll cover those in detail below.

What do I need to know about LLCs?

Advantages of LLCs

• Quick and easy to setup: Paperwork, documents, and regulations for setting up an LLC are very simple.

• Inexpensive to create: You can typically form an LLC for around $300 or less, which is inclusive of state filing fees (it’s more expensive to form LLCs in some states including Massachusetts, Illinois, Tennessee and Texas).

• Limit personal liability: Because an LLC is a separate legal entity, any liabilities it has (debts, obligations, lawsuits, etc.) belong to it alone. This protects your personal finances and assets.

• Easy to maintain from a legal perspective: LLCs don’t need to hold formal meetings, assign a board of directors, or meet complex rules and regulations.

• Simple for taxation purposes: Income earned through an LLC flows through to the owner's personal tax returns, where it’s taxed as normal income (you will have to pay self-employment tax in addition to federal income tax).

• Simple for accounting purposes: Accounts for an LLC are easy to setup and maintain. That can mean lower professional fees for account preparation.

Disadvantages of LLCs

LLCs do have some disadvantages:

• Annual filing fee: You will need to pay an annual filing fee to your state government. Annual filing fees run from $0 to $800 (California).

• Separate records and accounts: Money that flows into and out of an LLC must be managed in a separate bank account and recorded for accounting purposes.

• Self-employment taxes: All profits earned by LLC members will be subject to self-employment taxes at around 15.3%.

How LLCs Are Taxed

LLCs are taxed as follows:

• Any profit made by the LLC flows through to the owner's tax return.

• LLC owners will need to pay several types of tax on those profits, specifically:

  • Self-employment tax (Social Security and Medicare), currently 15.3% for 2017.

  • State income tax, depending on your state’s taxation rules and rates

  • Sales tax, although the rules for this vary from state to state

  • Federal income tax

What Do I Need to Know About S Corporations?

Advantages of S Corporations

• They limit personal liability in the same way as LLCs.

• Easy transfer of ownership: Owners of S Corporations can easily sell or gift their stake in the business to others.

• Tax advantages: You can structure the money you take out of an S Corporation in such a way that you pay less self-employment tax. More info on that below! Disadvantages of S Corporations

• Formal business roles: S Corporations require shareholders, officers, and an appointed board of directors.

• Compliance requirements: S Corporations have to meet more stringent compliance, rules, and regulations. This includes financial reports, annual meetings, adopting bylaws, corporate formalities, and the like.

• Shareholders: An S Corporation cannot have more than 100 shareholders. All shareholders must be U.S. citizens or permanent residents. An S Corporation is limited to one class of stock.

• Domestic business entity: An S Corporation must be based in the U.S.

How S Corporations Are Taxed

S Corporations are taxed in the same way as LLCs, with one important exception. Profit from S Corporations flows through to its owner's personal tax returns in the same way as for an LLC, however:

• Part of the money that owners take out of an S Corporation would be classed as salary, and you pay self-employment tax at the regular rate of 15.3%.

• The rest of the money can be distributed as a “disbursement.” Self-employment tax is not payable on disbursements, although it is still subject to federal income and other taxes.

It’s this exception that makes the S Corporation an attractive choice.

What Do I Need to Know About C Corporations?

Advantages of C Corporations

• They limit personal liability.

• Shares: C Corporations can have any number of shareholders. Their shares can be traded publicly on stock exchanges, and shareholders do not have to be U.S. citizens or residents. They can also offer different classes of stock.

• There are no restrictions on the ownership of a C Corporation.

Disadvantages of C Corporations

• They have formal business and compliance requirements in the same way as S Corporations, although rules for C Corporations can be even more complicated.

• They’re a separate taxable entity, which results in double taxation (more on this below.)

How C Corporations Are Taxed

C Corporations are taxed very differently from LLCs or S Corporations. In addition to all the other taxes and expenses, they also have to pay corporate income tax. The corporate tax rates levied on C Corporation profits are as follows:

| Profit | Tax Rate | |---------------------------|----------| | Less than $50,000 | 15% | | $50,000 - $75,000 | 25% | | $75,001 - $100,000 | 34% | | $100,001 - $335,000 | 39% | | $335,001 - $10,000,000 | 34% | | $10,000,001 - $15,000,000 | 35% | | $15,000,001 - $18,333,333 | 38% | | More than $18,333,333 | 35% |

Corporate tax is paid in addition to all the other taxes business owners need to pay — self-employment, state, sales, and federal income tax. That means owners are often paying taxes twice on the same money, which some consider double taxation.

Why might I choose a corporation over an LLC?

A corporation might be a better choice for your business entity if one or more of the following are true:

• You want to take your company public and sell and trade stocks and shares — in which case, you will need a C Corporation.

• You want to have more than 100 shareholders, issue more than one type of stock, or have international shareholders — you will need a C Corporation.

• You want to easily transfer ownership — you will need a C Corporation or an S Corporation.

• You want to pay lower self-employment taxes than an LLC — you will need an S Corporation.

What if I want the tax advantages of an S Corporation without all the compliance and other hurdles?

Good news. You can combine the simplicity and ease of running an LLC with the tax advantages of running an S Corporation. Just form an LLC and elect to be taxed as an S Corporation. This is a common request, and the IRS is happy to allow LLCs to be taxed as S Corporations, together with the advantages that provides.

Note: This could save you money on your taxes, but it doesn’t give you any of the other advantages of an S Corporation.

How do I form an LLC or Corporation?

Forming an LLC or corporation is simple given the wide array of online formation companies who do most of the paperwork for you. Filing online can be done in as little as one day.