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The type of business entity you select for your company is an important choice.
Among the many forms of business structures available, most owners choose to operate as an LLC (Limited Liability Company), S Corporation or C Corporation. When compared to each other, each one enjoys both similarities and differences.
Usually (but not always), the differences help “narrow down” your choices in determining which form is best for your unique needs and business. For example, only S Corporations and LLCs offer pass-through income taxation, but the two have significant differences, such as the greater flexibility that LLCs offer compared to S Corporations.
CT Tip: LLCs are very popular for their flexibility and pass-through taxation, but if you plan on attracting venture capital or doing an initial public offering (IPO) in the future, a C Corporation could be a better choice.
In addition to choosing your type of business entity, you'll also need to select the state where you'd like to file to form your business entity - also known as your domestic state, formation state, or home state.
Many business owners choose to file with the state where they live and are doing business. But, you don't have to. You can choose any state in the nation as your formation state, regardless of whether you reside or do business in that state. For example, many businesses choose Delaware or another state well-known for its favorable business environment. If you form in Delaware and are doing business elsewhere, you'll need to also register or foreign qualify in the state where you're doing business (typically the state where you live).
LLCs, S Corporations, and C Corporations all offer their owners limited liability for business debts. Limited liability helps protect an owner's personal assets from being used to pay business debts (but not if you co-sign a business debt in your individual capacity). Business assets are subject to business debts. Personal assets are subject to personal debts. LLCs are commonly thought to offer somewhat stronger protection, although it depends on the situation.
Company assets (e.g., computer, business bank account and receipts) and the owner's personal assets (e.g., family home) are separated - there's effectively a "wall" or "veil" or "shield" (or similar term) between the two types of assets. In limited cases, this corporate veil might be pierced (e.g., if the owner failed to treat the business as a separate entity or used it to carry out a wrong or injustice). Although forming an entity is a necessary first step to obtain limited liability, how you run your business matters as well. It's important to keep business and personal assets separate, follow corporation meetings or other formalities, and keep a company in good standing.
An individual operating a business as a sole proprietor doesn't need to file any forms to start the sole proprietorship. An individual in business as a sole proprietor owns all business assets as an individual and is personally liable for all the business debts.
As a business, a sole proprietorship still has to comply with other business filings. For example, you may have to complete a DBA (doing-business-as) or obtain a home-based permit.
A significant “downside” to operating as a sole proprietor is that the business owner has unlimited personal liability for business debts. And, if the business has employees, the owner is also liable for acts of employees.
CT Tip: By operating a business as an LLC instead of a sole proprietorship, a single-owner of a business could obtain limited liability while still being taxed like a sole proprietorship.
A general partnership involves two or more co-owners (instead of just one owner) who carry on a business for profit. Like sole proprietorships, general partners have unlimited personal liability. Other types of partnerships, like the limited partnership (LP), limited liability partnership (LLP), and limited liability limited partnership (LLLP) offer limited liability. However, LLCs and corporations are more popular today than these other forms of business. Often, LLCs have fewer restrictions and provide greater liability protection.
When selecting your business structure, if you ask yourself the question, “Will this matter to me in 5-10 years?” - the answer will almost always be “Yes.”
The type of entity you choose for your business affects taxes, day-to-day management, ultimate control, financing, and many other aspects of your business. For many business owners, the choice for a business form usually boils down to one of these three:
CT Tip: Licensed professionals (e.g., architects, lawyers, accountants) usually form a professional LLC (PLLC) or a professional corporation (PC).
LLCs and S Corporations are popular choices because they offer pass-through income taxation - business profits and losses flow through the entity and are taxable to the owners of the business.
CT Tip: The value of the right professional advice early on often pays for itself, many times over, by saving both money and headaches as your business grows. Talk with an experienced, knowledgeable advisor (attorney or accountant) at the outset about which type of business best serves your unique objectives and goals.
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