A corporation is created under state law to limit liability of the owners and to create certain tax results. It gives the business a unique name that sets it apart as an established, recognizable entity. Sometimes it is easier to obtain contracts and business from other corporations if your business is incorporated.

The choice between being a “C corp” or an “S corp” is just one of tax consequences. In a C corp., any retained earnings is taxed as income to the corporation; then when it is paid to the owners, it is taxed again as a dividend. In a small company, the way around this is to pay the principals a salary that is taxable earned income, but deductible to the company. This should distribute all of the company’s profit, leaving the company at roughly a zero income situation. The (potential) defect in this strategy is that all of the earned income is subject to FICA withholding (Social Security). There are other tax limitations in transferring assets out of the company. An advantage to this status is that 100% of benefits such as health insurance are deductible to the company without being income to the shareholders.

There a number of forms of partnerships. The common one is a general partnership. This is the basic form of two or more people getting together to undertake a business endeavor without filing any papers with any government entity. They should, and usually do, have a written agreement setting out the terms of their relationship. The defect in this form is that it doesn’t limit liability of the owners of the business. But it is very simple. The tax consequences are the same as a limited liability company. The creation is similar to, but simpler, quicker and cheaper than the limited liability company. One of the main benefits of creating a shareholders agreement for a corporation, an operating agreement for a limited liability company or a partnership agreement for a partnership, is that the owners must think and talk about their relationship. That usually strengthens things.