If you operate your business as a sole proprietorship or general partnership, you are personally liable for the debts and other legal liabilities of your business.  If you operate as a corporation, your personal assets are generally beyond the reach of business creditors.  For this reason, many business owners choose to operate in corporate form.

There are two types of corporations - “C” corporations and “S” corporations.  A C corporation must file returns and pay tax on business profits.  When the corporation distributes those profits to business owners in  the form of dividends, the owners must include the dividends as income on their individual tax returns.  Business profits are, in essence, taxed twice - once at the corporate level and again at the individual level.

Unlike a C corporation, an S corporation generally does not pay tax on business profits at the federal level.  Annual profits are allocated to each owner and reported as income on their individual tax returns.  Dividend distributions to the owners are not subject to tax.  The net effect is that S corporation profits are taxed only once.

In order to be an S corporation, your business must have no more than 100 shareholders.  Generally, the business must adopt a tax year that ends on December 31.  Also, each shareholder must agree, in writing, to elect S corporation status.  These written consents generally must be filed with the IRS by March 15 of the first year S corporation status is elected.  So if you are thinking of converting your C corporation to an S corporation and want to have the change effective for the current year, you must usually act by March 15.

Originally, the S corporation was designed to allow small business owners who operated as sole proprietors to gain the limited liability protection of corporate status with a pass-through tax device. Recently, the limited liability company (LLC) is also serving that role.

One of the biggest advantages of LLC’s is that it allows foreigners to be members/partners/owners of it unlike an S corporation.  However, the state of California is also “taxing” it on its gross income.  Besides, the pass-thru income from an LLC is also subjected to the self employment taxes.

In evaluating which business form is right for you, there is no “one-size fits-all” answer so always check with a professional first to determine which entity is right for your business.