6 types of corporations: Which is right for your startup?

Nearly every United States corporation started out small. So, it only makes sense that nearly every startup has to eventually think about what kind of entity they want to be and how they want to organize their company. This is why understanding the different types of corporations is important.

To help you make the right decision for your company, let's take a look at the various types of corporations and business structures. But first, let's explore how your business structure impacts your operations, from the bottom to the top.

How does your type of corporation or entity affect your business?

As far as the law is concerned, your business is a legal entity. Being such, there are a number of legal implications that come with each type of corporation and business structure. These legal implications range from personal liability protections to tax-exempt statuses to higher levels of federal income tax.

For example, an LLC ensures your personal assets are safe in the event of a business lawsuit or debt. But, an LLC doesn’t allow you to take advantage of the same kind of tax savings as, say, an S corporation.

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?

The different types of corporations and business structures.

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.

Before diving into this list, it’s worth noting the first four items listed are types of corporations. The following two are business entities that are not considered corporations.

S 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.

For example, let’s say you have a C corp with several shareholders who have all invested the same amount. 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. You’re also limited to no more than 100 shareholders, which can limit future growth.

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. 

C corporations.

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. But, this complicated corporate structure often necessitates an account or financial advisor, which is an added cost.

If your plan is to grow your business and eventually sell it, a C corporation can be a great way to keep your personal assets as a separate legal entity from your professional corporation. The ability to have a number of shareholders, even those from other corporations, gives C corps great growth potential, too. Just remember: you will likely incur financial costs in the form of paying advisors, especially come tax time.