7 Reasons to Choose LLC over C Corp for Tax Purposes
If you are starting a business, one of the most important decisions you have to make is how to structure your entity. There are different types of business entities, such as sole proprietorship, partnership, limited liability company (LLC), and corporation. Each one has its own advantages and disadvantages, especially when it comes to taxes.
In this article, we will focus on two common types of business entities: LLC and C corporation (C corp). We will explain what they are, how they are taxed, and why you might want to choose one over the other. Here are seven reasons to choose LLC over C corp for tax purposes.
1.LLCs have more flexibility in choosing their tax status
One of the main benefits of forming an LLC is that you can choose how you want to be taxed by the IRS. You can elect to be taxed as a sole proprietorship, a partnership, or a corporation. This gives you more control over your tax situation and allows you to optimize your tax strategy based on your specific circumstances.
C corps, on the other hand, have only one option: they are taxed as separate entities from their owners. This means that they pay corporate income tax on their profits, and then their shareholders pay individual income tax on their dividends. This is known as double taxation, and it can significantly reduce your after-tax income.
2.LLCs avoid double taxation
As mentioned above, C corps are subject to double taxation, which can be a major drawback for small businesses. If you form a C corp, you will have to pay taxes twice: once at the corporate level and once at the personal level.
LLCs avoid this problem by passing through their income and losses to their owners, who report them on their personal tax returns. This way, you only pay taxes once, at your individual tax rate. This can save you a lot of money in taxes and increase your cash flow.
3.LLCs can deduct more business expenses
Another advantage of forming an LLC is that you can deduct more business expenses from your taxable income. This can lower your taxable income and reduce your tax liability.
For example, if you form an LLC, you can deduct expenses such as rent, utilities, supplies, travel, advertising, legal fees, accounting fees, insurance premiums, and more. These expenses are considered ordinary and necessary for running your business.
C corps can also deduct business expenses, but they have more limitations and restrictions. For instance, C corps cannot deduct certain fringe benefits that they provide to their employees, such as health insurance, life insurance, disability insurance, and education assistance. These benefits are taxable to the employees as compensation.
4.LLCs can distribute profits and losses more flexibly
Another benefit of forming an LLC is that you can distribute profits and losses among your owners more flexibly. You can decide how much each owner will receive based on their contribution, agreement, or any other criteria that you choose. You can also allocate different types of income and deductions to different owners based on their preferences.
C corps do not have this flexibility. They have to distribute profits and losses equally among their shareholders based on their ownership percentage. They also have to distribute the same type of income and deductions to all shareholders.
5.LLCs can avoid corporate formalities and regulations
Another reason to choose an LLC over a C corp is that you can avoid some of the corporate formalities and regulations that apply to C corps. For example, if you form a C corp, you will have to:
- File articles of incorporation with the state
- Adopt bylaws and corporate resolutions
- Issue stock certificates and maintain a stock ledger
- Hold annual meetings of shareholders and directors
- Keep minutes of meetings and other corporate records
- File annual reports and pay annual fees to the state
- Comply with federal and state securities laws
These formalities and regulations can be time-consuming, costly, and complex for small businesses. They can also expose you to legal risks if you fail to comply with them properly.
LLCs do not have these requirements. They are simpler and easier to set up and maintain. You only need to file articles of organization with the state and pay a filing fee. You do not need to issue stock certificates or hold annual meetings. You do not need to follow strict corporate rules or comply with securities laws.
6. LLCs can protect their owners from personal liability
Another advantage of forming an LLC is that you can protect your personal assets from the debts and liabilities of your business. This is because an LLC is a separate legal entity from its owners. If someone sues your business or your business goes bankrupt, your personal assets (such as your home, car, bank accounts, etc.) are not at risk.
C corps also offer limited liability protection to their shareholders, but they have some drawbacks compared to LLCs. For example:
- C corps are more likely to be audited by the IRS than LLCs
- C corps are more vulnerable to piercing the corporate veil, which is a legal doctrine that allows creditors or plaintiffs to go after the personal assets of the shareholders if they can prove that the corporation is a sham or a fraud
- C corps are subject to more taxes and fees than LLCs, such as franchise tax, minimum tax, and accumulated earnings tax
7.LLCs can take advantage of pass-through taxation
The final reason to choose an LLC over a C corp is that you can take advantage of pass-through taxation. This means that you can avoid paying corporate income tax and instead pay taxes at your individual tax rate.
This can be beneficial for several reasons:
- You can avoid double taxation, as explained above
- You can use your personal tax credits and deductions to lower your tax liability
- You can qualify for the 20% deduction for qualified business income (QBI) under the Tax Cuts and Jobs Act of 2017, which reduces your taxable income by 20% if you meet certain criteria
- You can avoid the alternative minimum tax (AMT), which is a parallel tax system that applies to certain high-income taxpayers and limits their ability to use certain deductions and exemptions
C corps do not have these benefits. They have to pay corporate income tax at a flat rate of 21%, regardless of their income level. They cannot use their personal tax credits and deductions. They do not qualify for the QBI deduction. They are subject to the AMT if they have certain preferences or adjustments.
As you can see, there are many reasons to choose an LLC over a C corp for tax purposes. LLCs offer more flexibility, simplicity, and savings than C corps. They also offer more protection, deduction, and distribution options than C corps.
However, this does not mean that LLCs are always better than C corps. There are some situations where forming a C corp might be more advantageous for your business. For example, if you plan to raise capital from outside investors, go public, or attract employees with stock options, you might want to form a C corp.
Therefore, before you decide which type of business entity to form, you should consult with a tax professional and a legal expert. They can help you evaluate your specific goals, needs, and circumstances and advise you on the best option for your business.
LLC vs C Corp Tax: A Comparison
One of the most important decisions for a business owner is how to structure their company for tax purposes. There are different options available, such as a limited liability company (LLC) or a corporation (C corp). Each option has its own advantages and disadvantages, depending on the goals and needs of the business.
How LLCs are taxed
An LLC is a flexible business entity that can choose how it wants to be taxed by the IRS. By default, an LLC with one member is taxed as a sole proprietorship, and an LLC with two or more members is taxed as a partnership. This means that the LLC itself does not pay any federal income tax, but rather the profits and losses are passed through to the members, who report them on their personal tax returns. The members also pay self-employment tax on their share of the LLC income.
Alternatively, an LLC can elect to be taxed as a corporation, either a C corp or an S corp. To do so, the LLC must file Form 8832 (for C corp taxation) or Form 2553 (for S corp taxation) with the IRS. Once the election is made, the LLC will be subject to the same tax rules as a regular corporation.
How C corps are taxed
A C corp is a separate legal entity that pays its own federal income tax on its net earnings. The current corporate tax rate is 21%, which applies to all C corps regardless of their size or income level. A C corp can also deduct certain business expenses from its taxable income, such as salaries, rent, utilities, etc.
However, a C corp faces the problem of double taxation, which means that its earnings are taxed twice: once at the corporate level and again at the individual level when they are distributed to the shareholders as dividends. Dividends are not deductible for the C corp, and they are taxed at the shareholder’s personal tax rate, which can range from 10% to 37%. Additionally, some dividends may be subject to an additional 3.8% net investment income tax.
Advantages and disadvantages of LLC vs C corp tax
There is no definitive answer to which option is better for tax purposes, as it depends on various factors such as the amount and type of income, the number and type of owners, the growth potential, the exit strategy, etc. However, some general advantages and disadvantages of each option are:
An LLC taxed as a sole proprietorship or a partnership has the advantage of avoiding double taxation, as it only pays tax once at the individual level. It also has more flexibility in allocating profits and losses among its members, and it can take advantage of certain tax deductions and credits that are not available to corporations. However, an LLC taxed as a sole proprietorship or a partnership has the disadvantage of paying self-employment tax on its entire net income, which can be higher than the corporate tax rate. It also has less protection from creditors and lawsuits, as its members are personally liable for the debts and obligations of the LLC.
An LLC taxed as a C corp has the advantage of limiting the liability of its members, as they are not personally responsible for the debts and obligations of the LLC. It also has more credibility and attractiveness to investors and lenders, as it can issue different types of stock and raise capital more easily. However, an LLC taxed as a C corp has the disadvantage of facing double taxation, as it pays tax at both the corporate and individual levels. It also has less flexibility in distributing profits and losses among its members, and it must comply with more complex rules and regulations than an LLC taxed as a sole proprietorship or a partnership.
References:
https://www.irs.gov/pub/irs-pdf/p542.pdf
http://www.tax.ny.gov/pdf/publications/multi/pub20.pdf
https://www.irs.gov/pub/irs-soi/06coccr.pdf
https://www.irs.gov/businesses/small-businesses-self-employed/llc-filing-as-a-corporation-or-partnership
https://www.llcuniversity.com/irs/llc-taxed-as-c-corp/
https://venturesmarter.com/llc-vs-c-corp/
https://www.irs.gov/businesses/small-businesses-self-employed/limited-liability-company-llc
https://www.irs.gov/businesses/small-businesses-self-employed/corporations
https://www.sba.gov/business-guide/launch-your-business/choose-business-structure
