Incorporation is an important step in the life of a business, but unfortunately the true value of incorporating a business is often not seen until the business faces a negative situation such as a law suit or bankruptcy. A primary advantage of incorporation is the limited liability the corporate entity affords its shareholders (owners). Typically, shareholders are not liable for the debts and obligations of the corporation; thus, creditors will not come knocking at the door of a shareholder to pay debts of the corporation. In a partnership or sole proprietorship the owner's personal assets may be used to pay debts of the business.
Corporations are not without disadvantages. The primary disadvantage to a corporation is double taxation. Profits of a corporation are taxed twice when the profits are distributed to shareholders as dividends. They are taxed first as income to the corporation, then as income to the shareholder. All reasonable business expenses such as salaries are deductions against corporate income and can minimize the double tax. Further, the double tax can be eliminated by making an s corporation election.
Both the Limited Liability Company (LLC) and S corporation also provide the limited liability to the owners/shareholders of the company, without the potential disadvantage of double taxation. While like corporations these two entities also have advantages and disadvantages, it is a good idea to learn about all three when deciding what form your business should take.
| Characteristics | Sole
Proprietorship | General
Partnership | Limited
Liability
Company | S-Corporation | Corporation |
| Formation | No permission
required
| Agreement of
parties involved. No permission required | File with state for permission | File with state for permission | File with state
for permission |
| Duration | Dependent on sole
proprietor
| Dissolved by
death of partner
or bankruptcy | Typically
limited to a
fixed amount
of time | Perpetual | Perpetual |
| Liability | Sole proprietor has unlimited liability
| Partners have
unlimited liability | Members not
typically
liable for the
debts of the
LLC | Shareholders are typically not personally liable for the debts of the
corporation | Shareholders
are typically not personably
liable for the
debts of the
corporation |
| Simplicity of Operation | Relatively few legal requirements
| Relatively few
legal requirements | Some formal
requirements
but less
formal than
corporations | Formality of board of directors, officers, annual
meetings and
annual reporting | Formality of
board of directors,
officers, annual
meetings and
annual reporting |
| Management | Full control of
management and
operations
| Typically each
partner has an
equal voice
unless otherwise
arranged | Members
have
operating
agreement
that outlines
management | The corporation is managed by the board of directors who are elected
by the shareholders | The corporation
is managed by
the board of
directors who
are elected by
the
shareholders |
| Taxation | No taxable entity.
Sole proprietor pay all taxes
| Each partner
pays tax on
his/her share of the income and can deduct
losses against
other sources of income | If properly
structured
there is no tax at the entity level.
Income/loss is passed
through to
members of
the LLC | No tax at entity
level. Income/loss
is passed through to the
shareholders | Corporation is a taxable entity. |
| Pass Through Income/Loss | Yes
| Yes | Yes | Yes | No, corporate
losses can't be
deducted by
shareholder |
| Double Taxation | No
| No | No | No | Yes |
| Cost of Creation | None
| None | Filing fee
with the state | Filing fee with the state | Filing fee with
the state |
| Raising Capital | Difficult, unless individual puts in money
| Contributions
from partners or an addition of more partners
| Possible to
sell interests. Subject to
operating
agreement
restrictions | Sell shares of stock to raise capital | Sell shares of
stock to raise
capital |
| Transferability of Interest | No
| No | Possibly | Yes, subject to consent | Shares of stock in a corporation
are easily
transferable |
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