If you’re starting a business and choosing between an LLC, S-Corp, or C-Corp, this guide is for you. Each of these business entities has unique defining factors. Understanding your options and choosing the right business structure is an important decision – likely one of the biggest decisions you will make as a business owner. This decision can affect everything from how you are taxed to how you are paid, liability for yourself, and even your ability to attract investors.
In this guide, we will break down the differences between each of these business structures to look at pros and cons and give you all the details you need to make an informed decision.
Limited Liability Company
A limited liability company, also known as an LLC, is a flexible business structure that provides owners and managers with limited liability protection. Ultimately, this means that you protect your personal assets but you can still work on a pass-through taxation basis. Profits and losses pass through to the individuals and to their personal tax returns. The primary factor here is the ability to keep simple pass-through capabilities while also protecting your personal assets.
Taxation does have some flexibility but is defined by default as a pass-through entity. However, the taxing process is similar to that of a sole proprietorship or partnership, depending on the number of members of the LLC. LLC members do have the unique option to elect for taxation to be managed like an S-Corp or C-Corp while still maintaining LLC status.
Pros:
- Simple to set up and maintain
- Pass-through taxation prevents double taxation
- Limited liability protection
- Flexible management structure
- Option to elect alternative tax treatment
Cons:
- With traditional taxation, self-employment taxes apply to all profits
- Not ideal if you want outside investors
- Limited growth and scalability compared to other structures
An LLC can be used for many different things. It is most common for partnerships, small business owners, or freelancers who want to limit liability and include some tax simplicity without complete corporate formality.
S-Corporation
An S-Corporation, most commonly referred to as an S-Corp, is a business entity that is making a very specific tax election that LLCs and C-Corps don’t have the ability to make. This is a corporation, but it allows pass-through taxation rather than traditional corporate taxation. The primary benefit of this election is that profits have reduced self-employment taxes.
In this setup, profits are taxed on the shareholders personal tax returns because it all passes through. Owners are required to pay themselves a reasonable salary from the business, and that salary is subject to payroll taxes. Remaining profits can be distributed as dividends rather than a business profit, which makes them not subject to self-employment tax.
Pros:
- Pass-through taxation
- Reduce self-employment taxes
- Offers limited liability protection
- Easy to transfer ownership as necessary
Cons:
- There are strict IRS rules to follow
- Reasonable compensation is scrutinized by IRS
- Because of corporate requirements and payroll, it is more complex than an LLC
S-Corps are generally best for specific needs or requirements. This option is most often used by business owners who want to save money on self-employment taxes but still seek to benefit from pass-through taxation. This is particularly popular with solo entrepreneurs who see consistent profit, as well as service-based businesses.
If you are unsure whether this is a good fit, speak to a CPA to discuss it further.
C-Corporation
C-Corporations, also called C-Corps, are your basic and traditional corporate structure. This is a completely separate legal and tax entity from any owner, partners, members, or investors. The C-Corp has its own tax ID number and must pay its own taxes as well. Profits and losses are recorded under the umbrella of the corporation. It pays taxes on its own income, with shareholders taxed on dividends they receive. This is also where double taxation comes into play.
The corporation will pay corporate income tax at the designated rate. This rate is currently 21%. Shareholders will also pay taxes on any dividends they receive, and those taxes will vary depending on the type of dividend and personal tax rates.
Pros:
- Ideal for raising capital as unlimited shares can be issued
- No restrictions on shareholders
- More attractive to institutional investors or venture capitalists
- Fringe benefits are deductible by the corporation
- Its own entity and therefore own tax structure
Cons:
- Double taxation, once by corporation and once by shareholders
- Complex reporting and compliance requirements
- More formalities, such as annual meetings and a board of directors
Corporations are not right for every business. They are usually reserved for large companies, startups planning to seek funding, or businesses that want to reinvest profits into growth rather than immediate distribution.
Quick Comparison: LLC, S-Corp, or C-Corp
We put together a table for quick comparison of these three primary entities:
| Feature | LLC | S-Corp | C-Corp |
| Taxation | Pass-through | Pass-through | Double taxation |
| Self-Employment Tax | Yes | Only on salary | Not applicable |
| Owner Limitations | No | Shareholder restrictions | No limits or restrictions |
| Suitable for Investors | Not ideal | Limited | Yes |
| Formal Requirements | Minimum | Moderate | High |
| Best for | Small businesses | Seeking tax savings | Growth-focused or investor-backed businesses and large businesses |
Deciding What’s Right for You
The best thing you can do is talk with your tax advisor and legal counsel to determine the best structure for your business needs. They can help you understand all the complex details as well as what to be aware of before you decide.
These are some key things to consider:
- Will you need to attract investors or raise capital?
- Are you looking for a simple structure?
- Do you want pass-through taxation?
- What are your profits or anticipated profits?
LLC, S-Corp, or C-Corp: Work with Katherine M. Johnson, CPA
No matter your business structure or type of business, we are here to help. We can help you choose and understand your tax structure and manage business designs where taxation and bookkeeping are concerned.
Schedule your consultation with us today!
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