S Corp vs. C Corp vs. LLC

What’s the difference and which is right for your business?

If you’re starting a small business, then you’ve probably learned you need to determine the right business structure for legal and tax purposes. It’s an important decision, one that affects everything from how much tax your business will pay, to how easily you can acquire funding, to impacting your risk exposure in case your business gets sued.

The most common business entity types include sole proprietorship, general partnership, limited partnership, limited liability company (LLC), and corporation.

If you’ve already ruled out sole proprietorship and partnership entities because you need to minimize liability and maybe even raise capital, then you’re probably considering forming an LLC or corporation. In that case, you’ll need to identify which tax election is right for your business: S corporation or C corporation.

To help you get started in making that choice, here we take a quick look at the definitions, as well as a few of the advantages and disadvantages of each.

What is an LLC?

LLC stands for limited liability company, and it’s a popular choice for many small business owners. It’s a bit of a hybrid in that it operates like a partnership, but protects the owners from personal liability for business debts. In an LLC, owners and partners are called “members.”

Benefits:

• As an owner, you are not liable for business debts, and losses are tax-deductible against active income.
• You can choose how you want the IRS to tax your LLC: as a corporation or as a pass-through entity on your income.
• You’ll have greater flexibility in managing your LLC, without the recordkeeping and reporting obligations of a corporation.
• LLCs can offer different classes of company stock with different rights.
• There’s no limit to the number of members.

Drawbacks:

They’re not as easy to set up as a sole proprietorship or general partnership. You are required to register your LLC with the state.
There is no “LLC” tax classification, so unless you elect to be taxed as an S corporation or C corporation, you will be automatically taxed as either a sole proprietor or general partnership. Depending on your business’ particular circumstances, this may increase your tax liability.

What is an S Corporation?

An S corporation isn’t actually a business entity; it’s a tax election. When you have an LLC, you can decide how you want to be taxed, and S corp is one possible designation. Likewise, if your chosen business structure is a corporation, S corp is one of possible tax election.

Benefits:

• S corporations are independent legal structures; shareholders are not personally liable for the business debts and obligations.
• An owner of an entity taxed as an S corporation is considered an employee and is paid a salary. Only the wages paid to you as an employee are considered earned income subject to FICA tax for Social Security and Medicare.
• S corps are called pass-through entities: Other net earnings that pass through to the owners are considered dividend income, so are not subject to tax under SECA (Self Employment Contributions Act).
• As an owner, you can deduct 20% of qualified business income from your personal income tax return.

Drawbacks:

If you have an LLC and want to file under S corp status, your LLC must meet certain qualifications. Foreign LLCs, LLCs owned by nonresident aliens, and LLCs that are structured so that the owner is actually a corporation or partnership, do not qualify.

• You’re required to give yourself a reasonable salary, similar to what you would make if you performed your same role at another company; you cannot give yourself an artificially low salary.
• The tax return is more complex.
• You’re limited to a maximum of 100 shareholders and one class of stock.
• There is generally greater IRS scrutiny of S corporations.
• It can be difficult to raise money from investors.

What is a C Corporation?

This is another tax election and is the default applied to corporations who file articles of incorporation with the state government.

Benefits:

• C corporations are independent legal structures; shareholders are not personally liable for the business debts and obligations.
• It’s easier to raise investor capital as a C corp.
• You’ll have no limits on the number or classes of shareholders.
• If you reinvest most business profits back into your business (rather than paying dividends), this could bring tax benefits.
• You’ll have more flexibility if you wish to sell or expand your business.
• You’ll have the option to deduct 100% of charitable contributions, provided they don’t exceed 10% of the business’ total income.

Drawbacks:

• C corps are subject to the flat corporate tax rate (currently 21%), regardless of company size.
• C corps are subject to “double taxation,” meaning if corporate income is passed on to shareholders, it will be taxed again as personal income.
• As an owner, you won’t have the option of writing off the losses of the business on your individual income tax return.

Which business entity is right for you?

Generally speaking, if you own a small business, an LLC or LLC with S corp election status may be right for you. S corp status is not available to larger corporations and often not an attractive choice if you’re looking to raise a lot of capital, grow aggressively, or have the flexibility to sell.

Of course, these decisions require in-depth analysis of a multitude of factors. It may be in your best interest to consult a financial advisor or CPA who has experience advising on business structure. A knowledgeable professional can help make you aware of every single legal and financial implication, including tax advantages and disadvantages.

At Ironwood Wealth Management, we offer small business planning services, tax services and strategies for every scenario. Let’s talk about the pros and cons of each business entity and discover what’s best for you.