7 Reasons to Choose S Corp, C Corp or LLC for Your Business
If you are starting a new business or thinking of changing your current business structure, you may be wondering what are the differences and benefits of S corporation, C corporation and limited liability company (LLC). These are three common types of business entities in the US, and each one has its own advantages and disadvantages. In this article, we will explain the main features, tax implications and legal protections of each option, and help you decide which one is best for your business goals.
S Corporation
An S corporation is a type of corporation that elects to be taxed as a pass-through entity, meaning that the profits and losses of the business are reported on the owners’ personal income tax returns. This way, the business avoids double taxation, which occurs when a corporation pays taxes on its income and then distributes dividends to its shareholders, who pay taxes again on their personal income.
To qualify as an S corporation, a business must meet certain criteria, such as having no more than 100 shareholders, being a domestic corporation, having only one class of stock, and having only eligible shareholders (individuals, certain trusts and estates, but not partnerships, corporations or non-resident aliens).
The main benefits of an S corporation are:
Limited liability: The owners of an S corporation are not personally liable for the debts and obligations of the business, unless they have personally guaranteed them or committed fraud or negligence.
Pass-through taxation: The owners of an S corporation pay taxes only once on their share of the business income, at their individual tax rates. This can result in lower taxes than a C corporation, especially for high-income earners.
Tax savings: An S corporation can save taxes by paying its owners reasonable salaries and distributing the remaining profits as dividends. The salaries are subject to payroll taxes (Social Security and Medicare), but the dividends are not. This can reduce the overall tax burden of the owners compared to a sole proprietorship or a partnership, where all the income is subject to self-employment taxes.
The main drawbacks of an S corporation are:
Formation and compliance costs: An S corporation is more expensive and complex to form and maintain than a sole proprietorship or a partnership. It requires filing articles of incorporation with the state, paying filing fees, adopting bylaws, issuing stock certificates, holding annual meetings, keeping minutes and records, filing annual reports and paying franchise taxes. It also requires filing a special form with the IRS to elect S corporation status, and complying with various federal and state tax rules and regulations.
Ownership restrictions: An S corporation has limited flexibility in choosing its owners and transferring its shares. It can have only up to 100 shareholders, who must be US citizens or residents, and it can have only one class of stock with equal rights. It cannot have other corporations or partnerships as shareholders, nor can it issue preferred stock or stock options. It also needs the consent of all its shareholders to transfer its shares or change its business structure.
C Corporation
A C corporation is the most common type of corporation in the US. It is a separate legal entity from its owners (shareholders), who have limited liability for the debts and obligations of the business. Unlike an S corporation, a C corporation does not elect to be taxed as a pass-through entity. Instead, it pays corporate income tax on its profits at the federal and state levels, and then distributes dividends to its shareholders, who pay personal income tax on them. This results in double taxation for the owners of a C corporation.
The main benefits of a C corporation are:
Limited liability: The owners of a C corporation are not personally liable for the debts and obligations of the business, unless they have personally guaranteed them or committed fraud or negligence.
Unlimited ownership: A C corporation can have an unlimited number of shareholders from any country or background. It can also have multiple classes of stock with different rights and preferences. It can issue preferred stock or stock options to attract investors and employees. It can also sell its shares to the public through an initial public offering (IPO) or a secondary offering.
Tax deductions: A C corporation can deduct many expenses from its taxable income, such as salaries, bonuses, fringe benefits, retirement plans, health insurance premiums, travel expenses, advertising costs, research and development costs, depreciation and amortization expenses. It can also carry forward its losses to offset future profits.
The main drawbacks of a C corporation are:
Double taxation: The owners of a C corporation pay taxes twice on their share of the business income: once at the corporate level and once at the personal level. This can result in higher taxes than an S corporation or an LLC for some businesses.
Formation and compliance costs: A C corporation is more expensive and complex to form and maintain than a sole proprietorship or a partnership. It requires filing articles of incorporation with the state, paying filing fees, adopting bylaws, issuing stock certificates, holding annual meetings, keeping minutes and records, filing annual reports and paying franchise taxes. It also requires filing corporate income tax returns with the IRS and the state, and complying with various federal and state tax rules and regulations.
LLC
An LLC is a hybrid type of business entity that combines the features of a corporation and a partnership. It is a separate legal entity from its owners (members), who have limited liability for the debts and obligations of the business. However, unlike a corporation, an LLC can elect to be taxed as a pass-through entity, meaning that the profits and losses of the business are reported on the members’ personal income tax returns. Alternatively, an LLC can elect to be taxed as a C corporation or an S corporation, if it meets the eligibility criteria.
The main benefits of an LLC are:
Limited liability: The owners of an LLC are not personally liable for the debts and obligations of the business, unless they have personally guaranteed them or committed fraud or negligence.
Flexible taxation: The owners of an LLC can choose how they want to be taxed: as a sole proprietorship, a partnership, a C corporation or an S corporation. This gives them the opportunity to optimize their tax situation based on their income level, business expenses and personal preferences.
Flexible ownership: An LLC can have any number of members from any country or background. It can also have different classes of membership interests with different rights and preferences. It can issue membership units or options to attract investors and employees. However, it cannot sell its shares to the public through an IPO or a secondary offering.
Simple formation and compliance: An LLC is relatively easy and inexpensive to form and maintain compared to a corporation. It requires filing articles of organization with the state, paying filing fees, adopting an operating agreement, issuing membership certificates, keeping records and filing annual reports. It does not require holding annual meetings or keeping minutes. It also does not require filing a separate tax return with the IRS or the state, unless it elects to be taxed as a corporation.
The main drawbacks of an LLC are:
Self-employment taxes: The owners of an LLC who are actively involved in the business are subject to self-employment taxes (Social Security and Medicare) on their share of the business income, unless they elect to be taxed as a corporation. This can increase their tax burden compared to a corporation, where only salaries are subject to payroll taxes.
Limited life: An LLC may have a limited life span depending on the state law and the operating agreement. Some states require an LLC to dissolve upon the death, withdrawal, bankruptcy or expulsion of a member, unless the remaining members agree to continue the business. Some operating agreements may also specify a termination date or event for the LLC.
Which One Should You Choose?
There is no one-size-fits-all answer to this question. The best choice for your business depends on various factors, such as your income level, tax situation, liability exposure, financing needs, growth plans and personal preferences. You should consult with a qualified accountant, lawyer or business advisor before making a decision.
Here are some general guidelines to help you compare the three options:
- If you want to keep your business simple and avoid double taxation, you may prefer an S corporation or an LLC taxed as a pass-through entity.
- If you want to raise capital from a large number of investors or go public in the future, you may prefer a C corporation.
- If you want to have flexibility in choosing your owners and tax status, you may prefer an LLC.
- If you want to save taxes by paying yourself reasonable salaries and dividends, you may prefer an S corporation.
- If you want to deduct many expenses from your taxable income, you may prefer a C corporation or an LLC taxed as a corporation.
- If you want to avoid self-employment taxes on your share of the business income, you may prefer a C corporation or an LLC taxed as a corporation.
S Corp vs C Corp vs LLC: A Comparison of Business Structures
Choosing the right business structure for your company is an important decision that can affect your taxes, liability, and investment options. In this article, we will compare three common types of business structures: S corporation (S corp), C corporation (C corp), and limited liability company (LLC).
S Corp: A Tax-Saving Option for Small Businesses
An S corp is a tax status that allows a business to avoid double taxation, which means paying taxes at both the corporate and individual levels. Instead, the profits and losses of the business are passed through to the owners, who report them on their personal income tax returns. This way, the business only pays taxes once, at the individual level.
To qualify as an S corp, a business must meet certain criteria, such as having no more than 100 shareholders, having only one class of stock, and having only U.S. citizens or residents as shareholders. An S corp can be formed by electing this tax status with the IRS after registering as a corporation or an LLC with the state.
Some advantages of an S corp are:
- Lower tax rates for owners than a C corp
- Limited liability protection for owners
- Ability to raise capital by selling shares
- Ability to deduct business losses from personal income
Some disadvantages of an S corp are:
- More paperwork and compliance requirements than an LLC
- Restrictions on who can be shareholders and how many
- Difficulty in changing ownership or transferring shares
C Corp: A Flexible Option for Large Businesses
A C corp is the default tax status for a corporation. Unlike an S corp, a C corp pays taxes at both the corporate and individual levels. This means that the business pays corporate income tax on its profits, and then the shareholders pay personal income tax on any dividends or capital gains they receive from the business. This results in double taxation, which can reduce the net income of the owners.
However, a C corp also has some benefits that may outweigh the tax disadvantage, such as:
- No limit on the number of shareholders or their nationality
- No limit on the types of stock or classes of shares
- More flexibility in retaining or reinvesting profits
- More options for raising capital from investors or lenders
- More credibility and prestige in the market
Some drawbacks of a C corp are:
- Higher tax rates for owners than an S corp
- More complex and costly to form and maintain than an LLC
- More regulations and reporting requirements than an LLC
- Less control for owners over the management and direction of the business
LLC: A Simple and Flexible Option for Small Businesses
An LLC is a hybrid type of business structure that combines some features of a corporation and some features of a partnership. An LLC offers limited liability protection for its owners, who are called members. This means that the members are not personally responsible for the debts or liabilities of the business, unless they have personally guaranteed them.
An LLC also offers flexibility in how it is taxed. By default, an LLC is taxed as a sole proprietorship if it has one member, or as a partnership if it has more than one member. This means that the profits and losses of the business are passed through to the members, who report them on their personal income tax returns. This avoids double taxation and allows members to deduct business losses from their personal income.
However, an LLC can also choose to be taxed as a C corp or an S corp if it meets the criteria and elects this status with the IRS. This may be beneficial for some businesses that want to take advantage of certain tax deductions or credits, or that want to attract investors by issuing shares.
Some benefits of an LLC are:
- Easy and inexpensive to form and operate than a corporation
- Limited liability protection for members
- Flexibility in choosing how to be taxed
- Flexibility in managing and running the business
- Ability to distribute profits and losses among members as desired
Some drawbacks of an LLC are:
- Limited options for raising capital from outside sources
- Limited life span of the business, which may end if a member leaves or dies
- Less recognition and credibility than a corporation
There is no one-size-fits-all solution when it comes to choosing a business structure. Each type has its own pros and cons, depending on your goals, preferences, and situation. You should consult with a professional accountant or attorney before making a decision, as it can have significant legal and financial implications for you and your business.
References:
https://www.irs.gov/pub/irs-pdf/f2553.pdf
https://www.irs.gov/pub/irs-pdf/i2553.pdf
http://corp.delaware.gov/Aug09feesch.pdf
https://fitsmallbusiness.com/llc-vs-s-corp-vs-c-corp/
https://www.forbes.com/advisor/business/c-corp-vs-s-corp/
https://www.upcounsel.com/s-corp-vs-c-corp-vs-llc-vs-llp
https://www.nolo.com/legal-encyclopedia/s-corporations-faq.html
https://www.nolo.com/legal-encyclopedia/llcs
https://www.nolo.com/legal-encyclopedia/c-corporations-faq.html
