The USA has always been a fascinating market for entrepreneurs as it welcomes new products/services and provides an ecosystem to grow. It has a simplified tax structure with very low (negligible) rates of Corporate Tax. In some structures, there is no corporate tax at all. Compliance requirements are also simple and sorted. So, if you are planning to form a business entity in the USA, then you are on the right track and right page as well. Here you will learn about which type of business structure is suitable for your business in the USA.
Let us start with the types of business structures in the USA. The following are the major type of business structures in the USA –
1. C-Corporation
2. S-Corporation
3. Limited Liability Company
4. Partnership
Note - There are a few other business structures that exist and could be useful in some instances but those are not covered in this article because they are less commonly used and may not be useful for all.
Let’s get into the technicalities of all these structures to find out the one which suits your business –
C Corporation
C Corporation is an entity that is managed by the Board of Directors (Board) and the Board is elected by the shareholders. It is taxed pursuant to Subchapter C of the Internal Revenue Code. There are some distinctive features of this entity that makes it special and separate it from other structures –
- C Corporation is the only structure in the USA that can issue preferred stock as well as Common Stock;
- It can get its shares listed on the stock exchange;
- There is no limit on the number of shareholders in C Corp;
- It is a separate legal entity;
- Is taxed separately from the shareholder i.e., it pays corporate tax and if it distributes the income, then shareholders pay tax on the dividend received. Therefore, there is double taxation in C-Corporation.
- There is no restriction on ownership, i.e., foreign corporations and individuals can also become the shareholder in C-Corporation;
- Expensive to start; and
- Heavy oversight of regulations and formalities.
S Corporation
S corporations are corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S corporations to avoid double taxation on corporate income. S corporations are responsible for tax on certain built-in gains and passive income at the entity level.
To qualify for S corporation status, the corporation must meet the following requirements:
- Be a domestic corporation.
- Have only allowable shareholders.
- May be individuals, certain trusts, and estates and
- May not be partnerships, corporations or non-resident alien shareholders.
- Have not more than 100 shareholders.
- Have only one class of stock.
- Not be an ineligible corporation (i.e. certain financial institutions, insurance companies, and domestic international sales corporations).
S-Corporation is generally a corporation with a limited number of shareholders who are US-Citizens only. It is also a separate legal entity as C Corporation, but from the tax point of view, it Passover its profits and losses to the shareholders, and those profits are taxed as the business income of the individual shareholder and not that of the entity. It is governed by Sub Chapter S of the Internal Revenue Code and the term “S-Corporation” is an IRS designation for corporations that passes their income, losses, etc. to the shareholders. Some of the key features of S-Corporation are –
- Pass through taxation;
- No double taxation- no federal corporate tax; However, state franchise tax may be applicable depending upon the state requirements;
- It can be elected by US Citizens only;
- It can have a maximum of 100 shareholders only;
- It can issue common stock only and cannot issue preferred stock;
- Restriction on type of shareholders;
- It can not list its shares on a stock exchange;
- It is comparatively inexpensive than C Corporation; and
- Regulations and formalities are comparatively more relaxed than C Corporation.
In short, S Corporation is an entity formed by US Citizens, which has limited numbers of shareholders and the main benefit of an S Corporation is that is not taxed at the entity level. An S Corp can easily get converted into C Corp if it is required by the shareholders.
Limited Liability Company
A Limited Liability Company (LLC) is a business structure allowed by state statute. Each state may use different regulations, you should check with your state if you are interested in starting a Limited Liability Company.
Owners of an LLC are called members. Most states do not restrict ownership, so members may include individuals, corporations, other LLCs and foreign entities. There is no maximum number of members. Most states also permit “single-member” LLCs, those having only one owner.
A few types of businesses generally cannot be LLCs, such as banks and insurance companies.
A limited liability company (LLC) blends partnership and corporate structures. You can form an LLC to run a business or to hold assets. The owners of an LLC are members. LLCs protect its members against personal liabilities, i.e., it provides the benefit of Limited Liability. Some important features of LLC which differ it from S Corporation are –
- There is no limit on the number of members in an LLC.
- There is no restriction with regard to the citizenship or residency of members in an LLC.
- An LLC can have corporate as well as individuals as members.
- An LLC has the option of pass-through taxation.
- An LLC cannot issue preferred stock.
- An LLC is taxed as a corporation. As far as taxation is concerned, you should consider the following -
o Members must make a formal tax election to be taxed either as a sole proprietorship, partnership or corporation.
o “Pass through taxation” like a general partnership is allowed.
o Tax status cannot be changed for 60 months without a special IRS authorization.
Partnership
A partnership involves 2 or more persons who run a business as co-owners.
There are 2 common types of partnerships:
General partnership involves 2 or more general partners* who share equal rights and responsibilities in managing the business.
Limited partnership involves at least one general partner and limited partner(s)*.
General partners own and manage the business, whereas limited partners serve as investors only.
Some key features of a partnership are:
- Partners decide the ownership structure and distribution of profit and losses.
- Partnerships file Partnership Return of Income.
- Each partner’s share of income is taxed at the individual level and there is no tax at the partnership level. However, state franchise tax may be applicable in some cases depending upon the state of registration.
- Each partner is responsible for paying taxes on their respective tax return.
*Limited partners
As a limited partner, you:
- Contribute an amount of money or property to the business when it’s set up.
- Are only liable for debts up to the amount you’ve contributed.
- Cannot manage the business.
- Cannot remove your original contribution.
*General partners
As a general partner, you:
- Are liable for all business debts.
- Control and manage the business.
- Can make irreversible (“binding”) decisions for the business.
A partnership must file an annual information return to report the income, deductions, gains, losses, etc., from its operations, but it does not pay income tax. Instead, it "passes through" profits or losses to its partners. Each partner reports their share of the partnership's income or loss on their personal tax return.
Partners are not employees and shouldn't be issued a Form W-2. The partnership must furnish copies of Schedule K-1 (Form 1065) to the partner.
Comparative Analysis -
Type of Organization | Partnership | LLC | C-Corporation | S-Corporation |
Separate taxation as an entity (Federal Corporate Tax) | Separate taxation is not there, tax of firm is clubbed with the tax of partners as their personal business tax. | Separate taxation is optional.Income/ expenses can be merged with the personal income of shareholders. | Separate taxation is mandatory. | Separate taxation is optional. Income/ expenses can be merged with the personal income of shareholders. |
Option to choose any scheme of taxation | No | Yes, members can formally elect to be taxed either as a sole proprietorship, partnership or corporation. | No | Yes, members can opt for pass through taxation. |
Franchise tax | It is a state specific tax and varies from state to state. | It is a state specific tax and varies from state to state. | It is a state specific tax and varies from state to state. | It is a state specific tax and varies from state to state. |
Type of stocks that can be issued | NA | Common | Common and preferred | Common |
Maximum members / shareholders | No limit | No limit | No limit | 100 |
Restriction w.r.t citizenship | No | No | No | Only US Citizens can elect a S Corp. |
Listing of stock | Not allowed | Not allowed | Allowed | Not allowed |
Suitability | Small business. | Small business where limited liability is preferred and no venture capital investment or public funds are required. All / few shareholders are not the citizens of the USA. | Business where limited liability is preferred and venture capital investment or public funds are required. | Small business where limited liability is preferred and no venture capital investment or public funds are required and all shareholders are USA citizens. |
Conclusion –
If you are a citizen of the United States and want to start a domestic business then S Corporation is a good option. If you are not a citizen of the United States and want to start a small business with your own funds then LLC is a good option. But if you want to list your business entity or want to raise funds from banks or venture capitalists or want to issue preferred stock, then C Corporation is a good option. Although many other factors are required to be considered while choosing the right business structure & selection of state for doing business in the United States, therefore we suggest you have a formal business-specific legal opinion or consultation from us before deciding upon the same.
This article has been based on the following resources:
Disclaimer -
This publication is intended as a general overview and discussion of the subjects dealt with and does not create any business relationship or advice. It is not intended to be, and should not be used as, a substitute for taking legal advice in any specific situation. The author will accept no responsibility for any actions taken or not taken on the basis of this publication.
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