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Related Terms What Is a Business? A business is an individual or group engaged in financial transactions. Read about types of businesses, how to start a business, and how to get a business loan. What the Entity Theory Tells Us The entity theory is the theory that the economic activities, accounts, and liabilities of a business should be kept distinct from those of its owners.
It protects the owners' assets against creditor claims. Company A company is a legal entity formed by a group of people to engage in business. Learn how to start a company and which is the richest company in the world. As a startup, your company likely exists as a sole proprietorship or general partnership. But, as your company grows and your structural and financial needs shift , you'll likely need to change the type of business entity you're classified as. So, what types of corporations and entities are out there?
When it comes to types of corporations, there are typically four that are brought up: S corps, C corps, non-profit corporations, and LLCs. But, there are additional business structures as well, some of which could be the right fit for your company.
The following two are business entities that are not considered corporations. An S corporation is a business entity that passes almost all finances through to its shareholders. These finances include income and losses, as well as tax deductions and credits. By passing all of these finances through to shareholders, S corporations are able to be taxed like a partnership but gain corporate perks. More specifically, this means that shareholders are responsible for income and loss.
The S corp pays specific corporate taxes pertaining only to passive income and gains outside what the shareholders keep. This allows S corps to avoid the double taxation that often comes with C corps.
Before those shareholders see their profit, your company first has to pay corporate taxes on the income generated. Then, the already-taxed money is paid out to the shareholders as profit, who report it on their personal tax returns and pay tax again. With an S corp, the profits are passed directly to the S corp shareholders, meaning shareholders are responsible for the taxes.
This allows the S corporation to avoid corporate tax, as the profits are being taxed at a personal level when the shareholders report it on their income tax returns. But, there's a catch: any shareholders of an S corp can't be corporations, nor can they be partners with the company.
This means shareholders are generally part of a trust or estate, or are individuals and non-profits. This limits who can be a shareholder, but again, allows you to take advantage of lower corporate taxes in many cases. S corporations can be general partnerships, LLCs, or corporations, making them rather flexible. While there are certain tax benefits, it's worth noting the IRS tends to pay extra attention to S corporations.
This is because the structure provides loopholes through which shareholders may try to evade taxes. For example, an S corp could claim employee pay is actually a distribution and avoid taxes. A C corporation is similar to an S corporation, in that it can be a partnership, corporation, or LLC.
A C corp is also privy to certain tax benefits, chief of which is that the profits of the company are taxed independently of the profits of the owners. Unlike S corps, a C corp can have any number of shareholders from any background. This means C corp shareholders can also be employees of the corporation itself. But, a C corp must have a board of directors. The board of directors acts as the decision-makers for the company, while the shareholders are more like the financial backing.
C corporations can be hit with double taxation, however, which happens when the profits of the company are taxed at the corporate level and then again on individuals' income tax returns. This is often avoided by spreading profits out to employees as benefits, which allows the corporation to be taxed at a lower rate on a personal tax return. They must also file a certificate of partnership with the state. Limited partnerships allow partners to limit their own liability for business debts according to their portion of ownership or investment.
Corporations are, for tax purposes, separate entities and are considered a legal person. Then, any income distributed to the shareholders as dividends or profits are taxed again as the personal income of the owners. Similar to a limited partnership, an LLC provides owners with limited liability while providing some of the income advantages of a partnership. Essentially, the advantages of partnerships and corporations are combined in an LLC, mitigating some of the disadvantages of each.
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