As business law attorneys, our job is to assess and explain the risks and benefits of various business entities to our clients.
However, there is a significant lack of data on the relative popularity of the different business entity types on the internet, so we created this resource to help explain some of the more helpful facts about these entity types to our clients.
Specifically, the IRS publishes federal tax return data for each of the seven popular legal entity types through the statistical resource pages on their website.
Of particular note is the Integrated Business Data page, found under SOI Tax Stats, which breaks down the total number of returns, income, and other factors reported to the IRS by these legal entity types for the years of 1980 through 2015.
In this article, we’ll explore several key insights we can take from the data presented in these spreadsheets as it relates to business registration as a legal field.
Note, however, that this article is not intended to be tax advice, and that as lawyers we will generally refer you to an accountant if you have any tax-specific questions about incorporating or managing a business.
This article merely discusses the legal side of things and the general pros and cons of registering under different business structures.
Contents
- A Quick Look at Common Business Structures
- Analysis of Business Structure Statistics [1980-2015]
- Tentative Business Structure Data [2015-2018]
- Business Structure FAQs
- Key Takeaways
A Quick Look at Common Business Structures
For this article, we’ve divided our data into the common business classifications used by the IRS in their Statistics of Income Bulletin datasets.
Notably, the IRS divides these business structures into corporations (C corporations, S corporations, 1120-RIC corporations, and 1120-REIT corporations), partnerships (general, limited, and LLC), and sole proprietorships (non-farm).
However, it’s important to note that these classifications are based on how each business type files their taxes, and does not correlate to how much they’ll pay or even who ends up paying in the end.
For example, in this list C corporations are the only entity type that are directly taxed by the IRS, while S corporations (like partnerships and LLCs) act as pass-through entities for taxation purposes.
We’ll explain this topic in a bit more detail below, but for now just remember that the business structure you choose will have a major impact on your tax liabilities and personal liabilities in the event of a lawsuit or other unexpected event.
If you’d like to learn more about business structures generally, please review the different types of entities available in your individual state.
C Corporations
C corporations are what most people think about when they imagine a standard corporation.
C corporation income is generally “double taxed,” first at the business level and again at the shareholder level for any dividend income.
Note that C corporations are the only entity type covered in this article that are taxed at the corporate level, as all the others are generally regarded as pass-through tax entities.
1120-RIC and 1120-REIT
These tax designations refer to specialized financial and real estate entities that are regulated in a very particular way.
Specifically:
- Regulated investment companies (RICs) use form 1120-RIC to report income, gains, losses, deductions, credits, and income tax liability for the prior tax year.
- Real estate investment trusts (REITs) use form 1120-REIT to report income, gains, losses, deductions, certain penalties, and income tax liability for the prior tax year.
Because these are very specialized fringe cases, we will largely ignore them in this article.
S Corporations
S corporations vary from C corporations in that they act as “pass-through” entities.
The income that the corporation receives isn’t taxed. Instead, the income is passed on to the shareholders, who then must include any profits or losses on their personal tax returns.
However, the requirements to become an S Corporation are tighter than those for a C Corporation.
For example, the business cannot have more than 100 shareholders, and all of them must be U.S. citizens. The corporation must also only issue one class of stock.
These problems, among others, can lead to problems in acquiring financing, so S Corporations are often a careful balance between the tax benefits and additional restrictions placed on them by their structure.
As one final important note, we use data from the IRS in our analysis below, meaning that LLCs that elect to be taxed as S corporations may inflate the number of S corporations a little.
Partnerships
Similarly to S corporations, partnerships do not pay tax on business income, and instead pass through any income or losses to the partners who own the business.
These partners will then include this income on their personal tax returns.
Note that the only difference between general and limited partnerships is that “limited” partners are usually investors who are only liable for their stake in the company.
For this reason, we will largely combine these two categories in this article.
Limited Liability Companies (LLCs)
Limited liability companies (LLCs) offer a great middle ground for businesses that want the limited legal liability of a corporation while also retaining the tax benefits of a partnership.
Just as with S corporations and partnerships, LLCs act as pass-through entities, allowing the members to claim any income on their personal tax returns while simultaneously not being personally liable for any debts taken on by the LLC.
Importantly, LLCs can elect to file as either a partnership or S corporation depending on the situation, making them a flexible option for individuals that want to maximize their tax savings.
Nonfarm Sole Proprietorships
The owner of a non-farm sole proprietorship must summarize the income and expenses of their business on their personal tax return.
Any net income or losses accrued by the sole proprietorship are thus added to the owner’s personal income and taxed at the applicable individual tax income rates.
Note that sole proprietorships are generally not a recommended business type, and are thus not helpful to business attorneys when advising clients on business law matters.
Analysis of Business Structure Statistics [1980-2015]
As noted above, the IRS reports information on businesses that operate in the United States via the Integrated Business Data page on their website.
An analysis of these statistics presents a variety of key insights that we will focus on in this article.
Before we begin, however, please remember that this article is not intended to be legal or financial advice, or even a statistical summary of the data published by the IRS.
Rather, it’s just a quick look at some basic insights that may prove helpful in explaining the business landscape of the United States and the incorporation best practices that underline it.
Finally, unless otherwise noted, all data used in this article comes from Table 1 on the IRS’s Integrated Business Data page.
Corporate vs. Pass-Through Tax Classification Popularity
The IRS broadly categorizes most businesses as either corporations (including C corporations, S corporations, and others such as 1120-RIC and 1120-REIT), partnerships (including general partnerships, limited partnerships, and limited liability companies), or sole proprietorships.
However, this distinction (corporation / partnership / sole proprietorship) fails to capture one of the primary concerns when choosing a legal entity for your business: tax planning.
Put simply, the two primary reasons to incorporate are (1) to mitigate the tax liability placed on the owner(s) of the business, and (2) to limit the legal liability of the owner(s) in the event something goes wrong.
In this context, all formal business entity types protect their owners from legal liability to various acceptable extents.
However, the IRS will also tax these entity types differently, leading to huge differences in the tax obligations between, for example, a C corporation and an LLC.
Specifically, the IRS divides all business types into corporate and pass-through entities for the purposes of paying taxes:
- Corporate Designation — The corporation must pay taxes on any income, then the owners will pay taxes on any dividends received from ownership of the company. Note that this leads to double taxation.
- Pass-Through Designation — All profits “pass through” the entity and are instead reported as the personal income of the owner(s).
As you might imagine, there are a variety of reasons to choose one legal structure over the other, especially due to the constant changes to both the corporate and the personal income tax rates we’ve seen over the past three decades.
In fact, changes from the Tax Reform Act of 1986 reversed the conventional orientation in which corporations were taxed less to one where pass-through entities had the tax advantage, hence the split seen in the graph above and the relative decline in the popularity of corporations for small and medium-sized businesses.
Importantly for this article, the only popular “corporate” business structure that remains is the C corporation, while S corporations, partnerships, limited liability companies, and sole proprietorships all count as pass-through entities.
Total Tax Filings by Entity Type
Breaking down this distinction a bit more, you can see the obvious split wherein business owners increasingly registered S corporations and LLCs throughout the 90s and early 2000s due to tax considerations and the relative flexibility these legal structures provide to their owners.
Specifically, S corporations jumped in popularity after the 1986 changes to the tax code due to the enormous tax savings gained by filing as a pass-through tax entity.
For example, a business that filed as a corporation in 1991 would have paid a 34% tax on any income at the highest income level, while an individual who filed in the same year would only have paid 31% at the highest income level.
This difference has stayed in the favor of pass-through entities since this 1986 change due to the double taxation of corporation profits at both the business and individual level, which produces a combined maximum marginal rate of greater than 50% (35% corporate + 23.8% individual) for most cases.
This can be compared to the average individual tax rate, which has hovered around the mid- to upper-thirties since the 90s.
Only recently have corporate tax cuts under the Trump administration (which lowered the corporate rate from 35% to 21%) leveled the playing field between the business entity types, and even then it’s still often better to file as a pass-through entity due to the double taxation mentioned above.
With this information in mind, it’s easy to understand how S corporations and LLCs have found themselves at the top of the pack, as their pass-through status is beneficial in almost all cases.
Finally, it’s important to remember that S corporations have been around since the 1950s, while the IRS only began reporting LLCs as separate line items in 1993, leading to a situation where S corporations are more numerous while the number of LLCs being registered is increasing at a much faster rate (as seen below).
Recent Tax Filings by Legal Entity Type [2009-2015]
As you can see from the data above (taken from tax returns for the years between 2009 and 2015), S corporations strongly lead the pack, outnumbering all the other line items by a factor of 2:1.
They also exhibit a steady growth over time of around 1.5% per year for a total increase in returns filed of 9.6% between 2009 and 2015.
The number of LLC filings, in comparison, is growing at a much faster rate of roughly 4.2% per year for a total increase in returns filed of 27.7% over the same seven-year period.
Adjusting the chart to remove 1120-RIC and 1120-REIT data, as well as combining the two types of partnerships into a single line item, shows a more accurate comparison between S corporations, LLCs, and the other entity types.
Namely, C corporations and partnerships are seeing a decline in the number of returns reported each year (indicating that there are less entities of these types) while sole proprietorships (a pass-through entity type without any liability protections on the legal front) also saw strong growth over the same period.
As additional context, we can look at a line graph showing the relative strength of S corporations and LLCs over time:
We can also view a stacked area graph to see how the relative proportion of tax filings changed over time:
As you can see, LLCs and S corporations are dominating the field as the preferred method of limiting both the tax liability and legal liability of business owners over time.
Tentative Business Structure Data [2015-2018]
While the IRS has yet to officially add business tax data for years after 2015 to their Integrated Business Data Statistics tables, we can find references to this data in other places (such as their Corporation Complete Reports) and add it to the spreadsheets we’ve been working with throughout this article for additional context.
As we can see from the table above, this additional data further supports the trends seen in the 2009 through 2015 data, with a small acceleration in the number of S corporations and a small deceleration in the number of LLCs being registered.
Adding this data back into our original spreadsheet, we can see that the general trends remain the same:
While future data may provide additional context for new businesses (particularly for businesses registered after the 2018 corporate tax cuts), the data leading up to 2018 shows a clear preference for pass-through entities, and particularly LLCs for new business registrations.
Business Structure FAQs
What is the most common business type?
Technically speaking, the most common business structure is a sole proprietorship by a significant margin.
However, this is primarily due to the ease in which someone can “fall into” this business type by simply doing business in their local area.
The most common type of formalized business structure is the S corporation, which accounts for roughly 45% of all registered businesses.
What is the most common structure for new businesses?
Most new business owners choose to register their businesses as either S corporations or LLCs depending on (1) how the registration will affect their taxes and (2) how they want to limit their personal liability in relation to their business.
While around the same number of S corporations and LLCs are registered each year, LLCs are often seen as the recommended option for small business owners due to their inherent flexibility and lower barriers to entry.
What is the difference between corporate and pass-through entities at the federal level?
A corporation (specifically referring to C corporations) is a legal entity that is wholly separate from its owners, and thus must pay taxes on any income it earns through the tax year.
This means that the business itself must pay taxes at the end of the year. Further, the owners of the business must pay taxes on any dividends received as a result of their ownership, resulting in double taxation at both the corporate and personal level for any profits generated by the business.
In comparison, a pass-through entity allows money to “pass through” the business without incurring a tax.
This means that the owners of the pass-through entity must pay personal income taxes on any profits recorded by the entity.
Put another way, while the entity must file a tax return to record any income it receives, it instead passes the profits (and associated taxes) on to the members and owners of the entity.
Why are LLCs categorized under partnerships on IRS documents?
LLCs are registered and regulated at the state level, and were not recognized by the IRS until 1993 when they included them as a line item under partnerships.
Specifically, LLCs embody the benefits of a partnership for tax purposes and the benefits of a corporation for legal liability purposes, meaning that at the federal level they are bundled with partnerships due to their taxation similarities.
To further complicate this matter, the IRS adopted a “check-the-box” rule in 1997 that allowed LLCs to decide on whether they should be taxed as partnerships or corporations.
For this reason, LLCs exist in an odd grey area between these two tax structures, and are normally categorized as partnerships on IRS documents.
Key Takeaways
After reviewing the data it’s relatively easy to settle on a few key takeaways:
- The Fall of Corporations — Corporations have become less popular since the 1986 changes to the tax code which made them a more expensive option over time due to factors such as double taxation.
- Partnerships Remain Steady — Despite a slight decline in the number of partnerships, they are still a solid choice for certain situations due to their pass-through status. However, in most cases it’s more beneficial to register as an LLC for the additional flexibility.
- S Corporations are the Most Popular — S corporations outnumber LLCs by a factor of close to 2:1, and still boast steady growth over time due to their long history, pass-through tax status, and corporate organizational structure.
- LLCs Show the Most Growth — New businesses are incorporating as LLCs at double the rate of S corporations, making LLCs the most common structure for new businesses in the United States.
- Pass-Through Taxation is a Major Benefit — Close to 80% of all businesses (excluding sole proprietorships) are registered as pass-through entities, showing the strength of this entity type for the large majority of businesses operating in the United States.
If you’d like to learn more about business incorporation, or have any questions regarding the process, please speak with an attorney immediately.
Starting a new business can be incredibly rewarding, but it’s also a practice in risk and liability management.
For this reason, we strongly recommend that you speak with an attorney before you begin to do business.
Further Reading
- 11 Ways an Attorney Can Help You Start a Small Business in Virginia
- How to Start a Business in Virginia: A 10-Step Guide
- Piercing the Corporate Veil and Virginia LLCs
- Virginia Business Structures Explained: LLCs, Corporations, and More
- Virginia Limited Liability Company Taxes
Key Resources
- SOI Tax Stats – Integrated Business Data — A page on the IRS website that lists business tax statistics for years from 1980 through around 2015. This page is the primary source of data that most studies of new business entity trends use, so it’s recommended that you browse through it if you want a deeper dive into the actual numbers behind the scenes.
Other Resources
- U.S. Small Business Administration — A Wonderful primer resource on the different types of business structures available throughout the country.
- Virginia Business One Stop — A website run by the Virginia Department of Small Business & Supplier Diversity. It provides links to resources that can help small business owners learn more about what it means to run a business in the Commonwealth, as well as an online tool to help you register your business with the Virginia SCC.
- Virginia State Corporation Commission — All businesses operating in the Commonwealth must register with the Virginia SCC. Their website also provides a large number of introductory articles on topics such as business structures, how to choose a business name, and more.
- IRS Business — The IRS provides a variety of articles and resources on topics such as business structures and how you should report your federal taxes throughout the year.
