Small businesses should almost always be organized as a corporation or as an LLC. Many organize as a Sole Proprietorship (this is what you are if you do nothing) or as a Partnership (with two or more partners). The problem with this is that if times get tough, any creditors can sue you (and your partners, if a partnership) for any business debt, and go after your house, your car, your savings, and any other personal property. There is no way to protect personal assets from liability with a proprietorship or a partnership. Worse, in a partnership, they can come after your personal assets for any debts incurred by your partner(s), no matter how outlandish.
With a corporation or an LLC, however, any debts against the company are only against the company, not your personal assets, unless you sign a “personal guarantee" for a loan. Let's go through the different types of entities you can set up for your business, and how they differ.
Limited Liability Corporations (LLC’s)
A Limited Liability Company (LLC) gives liability protection for all debts except your initial contribution (if any) to the LLC. It can have one, two, or many owners, as spelled out in its organizing document, the Operating Agreement. You must register it with the Secretary of State, and pay an annual registration fee. Unlike corporations, there are no detailed record-keeping requirements. Also unlike corporations, you do not have to list for public display who the officers are each year, so there is more anonymity from prying eyes; and you can buy and sell percentages of ownership interest and keep the records private. LLC’s can be taxed as either a flow-through entity (just added to your personal tax return), if there is only one owner, or as a partnership or as a corporation, depending on how you file with the IRS.
A Corporation also gives liability protection for all debts except your initial contribution (if any). Like an LLC, it can have one, two, or many owners, as spelled out in its organizing document, the Articles of Incorporation. You must register it with the Secretary of State, and pay an annual registration fee. You must list for public display who the officers are each year, and you can buy and sell stock (percentages of ownership) of the corporation.
There are two different ways a corporation can be taxed:
S - Corporations
First, you can file an election with the IRS to be a Subchapter S Corporation, often referred to as an “S-Corp." With this, you are taxed as a flow-through entity (just added to your personal tax return), if there is only one owner, or as if it were a flow-through partnership, if there are two or more owners.
C - Corporations
Second, you can be taxed as a regular corporation (sometimes called a “C-Corp"), which means the corporation files its own tax return. Most small business corporations do not like this, as it results in “double taxation"-- taxes are first paid by the corporation on its return, then any money you received from the corporation in salary or distributions must be taxed again on your personal tax return.
Corporations were originally set up for large companies (think General Foods, General Motors, GE, Wal-Mart, Delta, etc.) Corporations by law have many record-keeping and tax requirements; they were not originally intended for small mom-and-pop small businesses.
Most small business corporations do not annually record who the officers are, do not hold an annual business meeting with reports given, do not record changes in policies and procedures in writing, etc., since they cannot afford a full-time Secretary, CPA’s, etc. to produce and maintain adequate required records. Therefore, when there is a lawsuit against a small corporation, often all the opposing attorney has to do is prove to the court these records are not up-to-date, and make a motion that the “corporate veil be pierced," which means the corporation’s liability protection is wiped out, and the suing party can go after all the owner’s personal assets -- house, cars, savings, etc. as if no corporation existed (LLC’s do not have this problem). Fortunately, there is a way out of this common problem.
In Georgia (and many other states), a corporation can be set up underArticle 9, Chapter Two, Title 14 of the Georgia Codeas a “Close Corporation," also called a “Statutory Close Corporation" or a “Closely-Held Corporation." (An existing standard corporation can also be converted to a Statutory Close Corporation.) This type of corporation does not have the record-keeping requirements of a normal corporation, and, depending on how the Articles of Incorporation are written, can even do away with the Directors and Bylaws normally required by corporate status.
Like a standard corporation, a statutory close corporation must choose whether to be a C-Corporation or an S-Corporation with the IRS.
Summary Advice to Small Business Owners
Most small businesses find it most expedient to be either an LLC or a Subchapter S Close Corporation. However, situations can vary, and especially whether to be an S-Corp or C-Corp should be discussed with your CPA.