All businesses fall into one of five basic structures that define how it is organized, how it operates, and how it is taxed, and liability issues. Each structure has its own benefits and drawbacks, and what works for one company may prove disastrous to another. Learning the differences between business structures can help an entrepreneur successfully plan his company:
Sole proprietorship: A sole proprietorship is the simplest business structure. It allows a person to conduct business as themselves. Under this structure the owner and his or her company are viewed as one and the same. While this is an easy way to start doing business, it is important to be aware that a sole proprietorship does not protect the owner from any business liabilities. Partnership: A partnership is a simple business structure for businesses with more than one owner. There are two types of partnerships: general partnerships and limited partnerships. When considering this business structure, understand that owners maintain personal liability for the business. Partners can be liable for the actions of the other partner's actions. In a limited partnership, the limited partners may have limited liability.
Corporation: Forming a corporation establishes a business as a separate legal entity, providing owners with limited liability protection. There are two types of corporations: C-corporations and S-corporations. There are several key differences between these two types of corporations, including tax issues and shareholder restrictions.
Limited Liability Company: Limited liability companies are separate legal entities from their owners, but allow owners to report business gains and losses on their own personal tax returns. Owners are shielded from business liabilities under this structure. LLCs do not have the amount of formalities that are required of Corporations. In Tennessee LLCs can elect to be taxed as a C-Corp, S-Corp, Sole Proprietor, or Partnership.
In Tennessee, Corporations and LLCs have to pay filing fees and additional taxes that sole proprietorship or partnerships do not pay. You will need to determine if it will be cost effective to purchase insurance to limit your liability compared to the additional fees and taxes.
What is the difference between C-corp and S-Corp?
In the end, C-Corps and S-Corps are very similar. The following traits are common to both: Liability Protection: Shareholders are generally not responsible for business debts or business liability. Liability protection can be sacrificed, however, if the company does not remain compliant.
Corporate Structure: Unlike LLCs, corporations must have a structure that breaks down into shareholders, directors and officers.
Shareholders own the company. They elect the board of directors
Directors oversee larger issues, such as corporate goals, affairs, and decision-making. They elect officers
Officers deal with day-to-day business affairs.
Corporate Documents and Compliance: Both need to file certain documents with the Secretary of State in Tennessee. Typically, these are the Articles of Incorporation. Furthermore, corporations have obligations such as issuing stock, paying fees, adopting and enacting bylaws, and holding shareholder and director meetings (as well taking meeting minutes at these meetings).
The Differences The main differences between the two fall into three categories: ownership, shareholder rights, and taxation. Ownership: C-Corps allow unlimited amounts of shareholders and thus are a great choice for larger businesses. S-Corps may have no more than 100 shareholders and these shareholders must all be residents of citizens of the United States. Furthermore, while C-Corps can be owned by other corporations, LLCs, or even trusts, S-Corps cannot.
Shareholder Rights: When forming a C-Corp, you can choose to have several different strata of shareholders, ones whose votes count for more or less than other members. Typically, early owners or founders have a more sizable say in voting, and thus, the operation of the business. S-Corps, on the other hand, have just a single type of shareholder. As such, it can be easier for C-Corps to expand, and sell shares, as additional flexibility is a solid advantage.
Taxation: First off, for either entity, personal income tax is paid on dividends and salary drawn from the company. That said, C-Corps also pay taxes at the corporate level, while S-Corps, like LLCs, are pass-through entities. What’s all this mean? That C-Corps have a possibility of double-taxation. In a C-Corp, corporate income is taxed at the corporate level, and dividends are taxed at a personal level.
What does it mean to "Pierce the Corporate Veil?"
A key reason that business owners choose to form a separate business entity is so they won’t be held personally liable for business liabilities. However, courts will sometimes hold a business’s owners, members, and shareholders personally liable. When this happens it’s called “piercing the corporate veil.”
Generally, when evaluating if a corporation is legitimate – if the corporate veil should be pierced – courts look at the following factors:
Corporate Formalities: Did the corporation follow proper procedure, for example in its formation and appointment of directors, issuance of stock, the holding of its annual meetings, the filing of annual reports with the state, and the maintenance of its own property, and financial books and accounts? Or were the procedures not followed, was the corporation dependent on property or assets of a shareholder which it did not technically own or control, or were the corporate finances commingled with those of its shareholders? Individual Control: What amount of financial interest, ownership and control did the principals maintain over the corporation?
Personal Use: Did the principals use the corporation to advance personal purposes?