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Choosing the best business entity for tax and liability purposes

This article compares the tax and liability benefits of limited liability companies and corporations.

When forming a new business or changing the structure of an existing business, one of the most important steps will be choosing what kind of entity the new business will be, such as a sole proprietorship, partnership, or corporation. For most business owners, there are two main considerations when choosing a business entity: liability and taxes. A business entity that provides maximum liability protection while also increasing the business' tax benefits is ideal. To that end, below is a comparison of three different business entities: limited liability companies (LLCs), C-corporations, and S-corporations.

Limited Liability Companies (LLC)

LLCs have become an extremely popular way to structure a business. As Forbes points out, whereas in the past when most sole proprietorships outgrew their business structure they became a corporation, today it is more common for them to become an LLC. That's because an LLC retains the flexibility of a proprietorship, with some of the liability and tax protections of a corporation. Like a corporation, personal and business finances are kept separate and owners generally cannot be held liable for the business' losses. On the downside, LLCs often have a difficult time attracting outside investors and they are not recognized outside the United States.

C-Corporations vs. S-Corporations

The other business entity that is best for protecting liability is the corporation. But there are two types of corporations, S-corporations and C-corporations, and many people understandably get confused about the differences between the two. As Fox Business notes, every corporation is initially founded as a C-corporation. A corporation only becomes an S-corporation by completing IRS Form 2553.

Both C-corporations and S-corporations are considered separate legal entities, meaning that owners (shareholders) generally enjoy broad liability protections and neither shareholders nor directors can have their personal assets seized to pay for the debts of the corporation.

The main difference between the two entities is how they are taxed. C-corporations are double-taxed because they must pay corporate tax and then shareholders pay personal income tax on the profits they make from the corporation. S-corporations avoid double-taxation by passing through all income or loss to their owners, meaning they typically pay no corporate tax. On the other hand, there are disadvantages to S-corporations, such as the inability to have more than 100 shareholders and a requirement that all shareholders be U.S. citizens or legal residents.

Choosing the right business entity

Choosing the right business entity can have major tax and liability implications, as the above article demonstrates. That's why the decision should not be made lightly , but should rather be come to with the assistance of an experienced business and corporate law attorney. An attorney can help business owners understand which business entity is most beneficial to their situation and help them with the various legal steps involved in forming a new business.

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