However, with respect to taxes, the C corporation itself is considered a taxable entity. That means that it files a tax return and pays income taxes on its net income. If the corporation then distributes income in the form of dividends to the shareholders, they are taxed again on the income.

This is often referred to as the double tax of corporations. Most small businesses can avoid or reduce this double tax by paying substantial compensation and providing benefits to the shareholders who work in the business.

Compensation and benefits are generally tax deductible to the corporation as a business expense. If a benefits plan is structured properly, the value of the benefits may not be considered taxable income to the employee.

Compensation must be reasonable or there is the possibility that the IRS could reclassify it as a dividend making it subject to the double tax problem. The other method of avoiding or reducing the double tax is to elect an S corporation status. Unlike a C corporation, an S corporation itself is not a taxable entity.

The S corporation files an informational tax return on form 1120S, but the corporation itself does not pay taxes on the net income of the business. An S corporation is a pass -through entity which means the profits or losses are reported by the owners (shareholders) on their individual tax returns.

An S corporation can also pay compensation to shareholders who work in the business. If the S corporation distributes income to the shareholders, there is no double tax because the S corporation as an entity does not pay any tax. Only the shareholders of the S corporation report and pay income taxes on their prorata share of the business net income.

In most small private corporations, the shareholders are actively involved in the business and also serve as officers and directors of the company.

There are some larger corporations with a substantial number of shareholders who choose to remain private for several reasons including more privacy and the high cost of going public and maintaining a public company.

A public corporation is one that is authorized to sell its stock to the public. Usually, only companies with substantial revenue and a large number of shareholders can afford the cost to go public and comply with the many regulations imposed on public companies by the securities laws and other governmental regulations.

It has been suggested that the liability treatment of S corporations (which are treated just like regular C corporations for liability purposes) is more predictable than LLC’s because they have been available for many more years than LLC’s and have a substantial body of legal cases which act as precedents in determining issues of liability. LLC’s are relatively new and there are fewer legal cases to help predict issues of liability.

Both S corporations and LLC’s are pass-through entities for tax purposes. The entities file an informational tax return but the individual owners, which are called shareholders in an S corporation and members in an LLC, report income and/or losses on their individual tax returns.

There are some differences in the way basis is determined for the purpose of determining losses. A discussion of tax basis is beyond the purpose of the book but can be discussed with your tax advisor.

Just keep in mind that if you are expecting substantial losses in the early stages of the business or if you are borrowing substantial sums of money for your business, the LLC may allow you to write off greater losses than you could if operating the business as an S corporation.