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Types of Corporations

Types of Corporations Explained


What Kind of Corporation?

C.... S... LLC ....Non Profit  ?

The material presented on site is of an informational nature only; it is not intended to provide legal counsel, nor substitute for the services and advice of competent, experienced, licensed legal professionals. It is strongly recommended that you consult with a qualified attorney or licensed financial professional prior to setting up any kind business entity, or if you have questions regarding your compliance with any tax, licensing, advertising or marketing regulations.

So, now we know that a corporation is, at the most basic level, nothing more than a group of people (even if it's a group of one) banding together under some type of law or regulation, for the purpose of minimizing risk and protecting assets. You should also know by now that corporations are taxed differently than individuals, enabling the owners to keep more of what they make. Since a corporation exists as a separate entity, it has continuity in the event of the principal's death, and ownership interest can be easily transferred.

The kind of corporation you'll want to form depends on a number of factors. Are you still planning to run your net-based business by yourself, with a partner or partners, or will you be hiring employees or contracting with third parties? You may wish to consult with your tax advisor or accountant when considering which kind of corporate entity to form with your business.

C-Corporations

This is the most common kind of corporate entity. Most major companies as well as numerous smaller ones fall into this category. Although widely used, a C-Corp structure may not be the best one for a small net-based business run by one person. The reason is that Federal and most State laws require that the operations of a C-Corporation be overseen by a board of directors and that shareholders be consulted on major business decisions. This Board of Directors manages the corporation and appoints officers to run things on a day-to-day basis.

If you plan to expand your Internet business substantially – if you believe it has a shot at becoming the next Google or Craig’s List - a C-Corporation is definitely the way to go. As a C-Corporation, you have no limit to how many shareholders you may have, allowing you to raise unlimited amounts of capital through the sale of stock. A C-Corporation is also able to deduct the cost of employee benefits (such as health insurance) as a cost of doing business. Otherwise, if you plan on staying small and intend to maintain maximum control over as much of the operation of your business as possible, formation of an LLC or an S-Corporation is a better choice.


S-Corporations

An S-Corporation – sometimes called a “small business corporation” - is really little more than a C-Corporation that has chosen to operate under specific tax laws as outlined under Chapter One, Subchapter S of the Internal Revenue Code. The initial administrative paperwork required is the same, regardless of whether you are forming a C-Corporation or an S-Corporation, since this is done at the state level. Once this paperwork has been approved by the state in which you are incorporating, you’ll need to fill out and submit IRS Form 2553, also called “Election by a Small Business Corporation” .

With an S-Corporation, the shareholder (that’s you) is able to pass corporate earnings and profits directly through to his/her own personal tax return. Anyone providing work for an S-Corporation (including yourself) needs to receive a wage or salary meeting “the standards of reasonable compensation.”


An S-Corporation Or An LLC?

Let’s face it, not everyone is into paperwork…and formation and maintenance of a corporate entity requires a fair amount of it. On the other hand, it’s a relatively small matter to form an LLC. According to Nolo’s Guide to Starting and Running a Small Business:

"the relative simplicity and flexibility of the LLC make it the better choice. This is especially true if your business will hold property, such as real estate, that's likely to increase in value."

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That statement about property is something to think about if your Internet business is an informational website that generates income on its own, such as CraigsList or a pay-per-use site. Digital property has the same potential to rise and fall in value as real property (just ask AltaVista). Even if your website doesn’t generate income directly, if you’re getting a fair number of hits per month “ say, 100,000 or more “ simply the domain name (if you have one) can be valuable.

Beyond the fact that forming an LLC is a one-step process requiring little in the way of red tape, you won't have to worry about annual meetings and keeping minutes of those meetings in the way corporations must do. Dividends of S-Corporations must be distributed among shareholders based on the number of shares they hold, regardless of whether or not they contributed to the business in any tangible way (in other words, YOU could put in the hours of actual labor while THEY sit around the pool waiting for the dividend check “ which in theory, could mean your shareholders may wind up with the lion's share of profits!) With an LLC, profits and losses are divided up among the members in any way they see fit. Finally, an LLC can be owned and operated by anyone, whether they are a citizen, a resident alien, or another person or corporate/business entity inside or outside of the U.S. An S-Corporation, on the other hand must be owned by a "œnatural person" who is a U.S. citizen or a legal resident “ it cannot be owned by another corporation or person outside of the country.


Limited Liability Company

The "Limited Liability Company," or LLC, is a corporate-type business organizational structure that is idea for small businesses and companies, combining as it does the advantages of Sole Proprietorship with the protection and tax advantages of incorporation. An LLC can consist of one person – which is very likely your case, if you are operating an online business. As an LLC, your personal assets are separate from those of the business, and therefore protected from loss in case the business should be sued for any reason.

In addition, an LLC is not taxed unless it chooses to be (see below); typically, you will pay Self-Employment tax on any profits you take out of the business.

The advantages of a Limited Liability Company:

  • No board of directors or shareholder meetings are required; an LLC can consist of just one person.

  • An LLC is an enduring entity, usually separate from the member(s), and can be passed on, transferred or sold; fewer legal complications result should the owner unexpectedly die.

  • Administrative paperwork and recordkeeping is easier.

  • Your assets are separate from those of the business, therefore you are not liable for damages caused, or debts incurred by the LLC.

  • Taxation is typically on profits taken out by you, not on the LLC. You may however elect to be taxed as a sole proprietor, an S-Corp or a “regular” C- corporation; your tax advisor can determine what is best for your particular situation.


Disadvantages of a Limited Liability Company:


  • Several states3 levy a franchise tax on LLCs. This is essentially a fee paid for the privilege of shielding one's personal assets.

  • It is more difficult to raise capital, since most investors are looking toward an eventual initial public offering of stock.

  • Any income you receive from an LLC is taxed at "ordinary income" rates, and is subject to FICA taxes (unlike dividend or share income).


Note that last point. Currently, dividends are taxed at a maximum rate of 15%, whereas – depending on the amount – wages and salaries are taxed up to 38% and may be subject to an additional “self-employment tax” of over 15%. In the next chapter, you’ll find that there are several types of corporate set-ups, and not 0every one is right for the small, single-person on-line operation.

Members of an S-Corporation pay Medicare and Social Security taxes only on money they actually receive as compensation in the form of wages or a salary – profits received as a dividend are exempt. In contrast, members of an LLC may be liable for these taxes on all profits made. This is especially true if yours is an online business that provides professional services in the fields of health care, the law or engineering and design. If this is the case for you, it’s a good idea to consult with your account or tax advisor on what is best for your business.

Another caveat for licensed professionals residing in the State of California: an LLC may not even be an option for you, since California law prohibits LLCs from rendering professional services as an individual. Other than that, California charges LLCs a yearly tax of $800 just for doing business in that state, plus an additional annual LLC fee based on a percentage of total yearly income from all sources.

This brings us to our next issue – once you’ve decided to incorporate, where should you do it? This is no small question, since the Internet has made boundaries between states – and even nations – a lot more permeable than they once were, especially when it comes to commerce. Nonetheless, if your business is a corporate entity, you’ll be required to have a “designated agent” as well as a physical address in each state in which you’re doing business. Fortunately, this is not as daunting a task as it may seem, and there are organizations online that will assist you in just this sort of thing for a nominal fee. Before we move on to that subject however, it’s worthwhile to consider the pros and cons of running a non-profit (503c) corporation.


The Way Of The Profits (And Non-Profits)

Most Business Owners and especially netpreneurs are hoping to strike it rich – and if you’re one of those clever enough and lucky enough to come up with something that people will pay good money for, chances are you’ll be one of them.

On the other hand, more and more people are discovering that there are things in the world to which a monetary price cannot be attached – and the value of which may not necessarily be measurable in dollars and cents. For example, the fine arts – contemporary painting or sculpture, modern classical music, and great theatre are institutions that rarely find any kind of support from commercial markets (in fact, the technical definition of “classical” music is that which is primarily state-supported – something commonly done in Europe, Japan and China, but almost never in the U.S.).

If you are among those who aspire to be a patron of the arts and are content to make a modest living while doing so, a Non-Profit entity may be for you.

Also called a “Not-for profit corporation,” a Non-Profit is a non-stock entity (in other words, it cannot issue stock to shareholders) that as the name implies, is not intended to make profits. Such corporations are founded with a specific goal or purpose in mind, usually – but not necessarily – related to education, charity work or the arts. As such, they may be – and often are – exempt from many taxes and tax regulations.

A Non-Profit may certainly generate income, and indeed needs to do so in order to stay in operation. It can accept, hold and trade monetary instruments as well as tangible goods, and – despite the name – can legally make a profit – technically called “revenue” - on such transactions. The use of such revenue – and how much revenue can be made legally - is subject to scrutiny, however, and is tightly regulated. Since it has “members” (like an LLC) rather than “shareholders” or “stockholders,” capital is generally raised by soliciting donations from the public, or from private industries. Depending on the purpose of your Non-Profit organization, such donations may be tax-deductible for the donor.

At this point, you may be wondering what the point is. After all, if you’re not allowed to make a profit, how is having a Non-Profit Corporation supposed to provide you with a livelihood? While it is true that a non-profit cannot issue stock nor pay dividends, it is still like any other corporate or LLC entity in that it can retain employees and provide reasonable compensation for its director(s).

Another major advantage to having a non-profit corporation – especially in the arts – is the ability to apply for government grants, such as those offered by the National Endowment for the Arts (NEA). In 1995, the new Congress changed numerous laws, making these grants unavailable to individuals. However, a non-profit organization can apply for these grants on behalf of individuals, should they wish to commission a work of art.


The same is true of charitable and educational organizations. Numerous Federal and State grants are available to non-profit organizations that cannot be applied for any other way. So – what is your passion? The arts? Education? Providing affordable housing to low-income people? Historical preservation? There are even non-profit sports organizations. You won’t get rich, but by incorporating as a non-profit entity, chances are good that you’ll be able to pursue activities that nourish your soul while retaining the ability to pay the bills.

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