Thinking about starting a business and different ways to structure it: LLC, S Corp, and C Corp. But you’re not sure which one to choose, right? Don’t worry. Each one of these taxes has its own rules, especially when it comes to how it is taxed, which can have a big impact on your profits and how much money you take home.
You might be familiar with Limited Liability Company because it’s popular and simple. The profits from the business pass through to your personal income, meaning you’re taxed as an individual, not the business itself. This keeps things straightforward, but it also means that all profits are taxed, even if you leave some money in the business.
Now, the S Corp is a bit different. Like an LLC, the profits pass through to your personal income, so there’s no double taxation. However, S Corps has stricter rules, like limiting the number of shareholders. A big advantage here is that you can pay yourself a salary and only pay payroll taxes on that, while the remaining profits aren’t hit with those taxes.
Lastly, there’s the C Corp. Unlike the other two, a C Corp is taxed separately from its owners, which can lead to double taxation—once at the corporate level and again when profits are distributed as dividends. But C Corps can attract investors more easily and have no limit on the number of shareholders.
1. Understand the Basics: LLC, S Corp, and C Corp
LLC is a business structure that protects your personal assets (like your house, car, and bank accounts) from business debts and liabilities. So, if your business gets sued or runs into debt, your personal belongings are generally safe. An LLC can be owned by one person (called a “single-member LLC”) or multiple people (a “multi-member LLC”).
An S Corp is not actually a type of business entity but rather a tax status that you can choose after your business is been formed as a corporation or an LLC. The S Corp election helps you avoid double taxation. S Corps also offers some additional benefits in terms of how your business income is taxed.
A C Corp. is a traditional corporation. It’s a separate legal entity from its owners, meaning the corporation itself can own property, incur debts, and be sued. C Corps are also subject to double taxation.
2. Understand How Each Is Taxed
Taxation is a big deal when it comes to choosing between an LLC, S Corp, and C Corp. It’s one of the main factors that could influence your decision.
LLC Taxation
When it comes to taxes, an LLC is like a chameleon. It can take on different forms depending on what you choose.
- Single-Member LLCs: If you’re the only owner of an LLC, the IRS treats your business as a disregarded entity. This means that for tax purposes, the LLC doesn’t exist separately from you. Instead, all the business’s income and expenses get reported on your personal tax return, usually on Schedule C. So, whatever profit your LLC makes is taxed at your personal income tax rate. The good thing here is simplicity—there’s no separate corporate tax return to file.
- Multi-Member LLCs: If your LLC has multiple owners, the IRS treats it as a partnership by default. The LLC itself doesn’t pay taxes. Rather, it passes through the income (or losses) to you as a owner, if you report your share on your personal tax returns. The LLC files a partnership return (Form 1065), but this is more for informational purposes. You, as the owner, are the one responsible for paying the actual taxes.
- Electing Corporate Taxation: Here’s where it gets interesting. Your LLC can choose to be taxed like a C Corp or an S Corp. If you opt for C Corp taxation, your LLC pays corporate taxes. Additionally, if your LLC pays dividends to you, those dividends may be taxed again on your personal tax return (that’s double taxation). However, if you choose S Corp taxation, your LLC may avoid double taxation.
S Corp Taxation
Remember that an S Corp is really a tax status rather than a separate type of business. Here’s why that’s important:
- Pass-Through Taxation: Like an LLC, an S Corp avoids double taxation because it’s also a pass-through entity. An S corporation itself doesn’t pay federal income taxes. But the income “passes through” to the shareholders, who then report their share of the income on their personal tax returns.
- Reasonable Compensation: One unique feature of S Corps that you should know is that if you work for your business, you must pay yourself a reasonable salary. This salary may be subject to payroll taxes, including Social Security and Medicare. Any leftover profits can be distributed to you as dividends, which are not subject to payroll taxes. This can lead to tax savings for you because dividends are taxed at a lower rate than ordinary income.
- Limits: S Corps do have some restrictions. For example, it can’t have more than 100 shareholders, and those shareholders must be U.S. citizens or residents. Also, S Corps can only issue one class of stock, which means all shares have to provide the same rights to dividends and distributions.
C Corp Taxation
C Corps have a different tax structure, and it’s often less favorable for you if you’re a small business owner due to double taxation. Check it out:
- Corporate Taxes: C Corps pays taxes on its profits at the corporate tax rate, which is 21% under the IRS rules. No wonder it was taxed as separate entities.
- Double Taxation: Here’s the kicker: When your C Corp distributes profits to you in the form of dividends, those dividends may be taxed again on your personal tax return. So, the same money may be taxed twice—once at the corporate level and again at your individual level.
- Retained Earnings: Also, Your C Corp can retain profits in the business without having to distribute them to you as a shareholder. This can help with reinvesting in your business without immediately incurring personal taxes. However, if your C Corp retains too much profit without a good business reason, it could be hit with an additional accumulated earnings tax.
3. LLC Taxation vs. S Corp vs. C Corp
You understand the basics of how each structure is taxed, right? Now compare the terms of taxation, liability protection, ease of setup, and other considerations.
Taxation
- LLC: Offers flexibility, and you can be taxed as a sole proprietor, partnership, S Corp, or C Corp. Pass-through taxation, where income is taxed on your personal return.
- S Corp: Also uses pass-through taxation but with the added benefit of potentially reducing self-employment taxes by paying yourself a reasonable salary and taking the rest as dividends.
- C Corp: This cooperation is subject to double taxation but can retain earnings in the business to potentially grow without immediate tax implications for the shareholders.
Liability Protection
- LLC: Provides strong liability protection. You don’t need to worry about your personal assets from business debts and lawsuits.
- S Corp: It offers strong liability protection, as it’s a corporation under the law.
- C Corp: C Corp offers liability protection to separate your personal assets from the business’s liabilities.
Ease of Setup and Maintenance
- LLC: Easier and cheaper to set up than a corporation. It has less paperwork and fewer ongoing formalities, especially for single-member LLCs.
- S Corp: A bit more complex, but you must file for S Corp status with the IRS by submitting Form 2553, and you need to adhere to the requirements, like paying yourself a reasonable salary.
- C Corp: The most complex and expensive to set up and maintain. File articles of incorporation, hold regular board meetings, keep detailed records, and comply with various corporate formalities.
4. Consider Which Taxes is Right for You
To consider which taxation is right for you
Starting a Small Business on Your Own or With a Partner
If it’s just you or you and a partner, and you want something simple to start with, an LLC might be the way to go. It gives you flexibility in how you’re taxed, protects your personal assets, and is relatively easy to set up and maintain. If you’re making decent money and want to save on self-employment taxes, you could consider electing S Corp status for your LLC.
Avoid Double Taxation but Have a Corporation
If you like the idea of being a corporation because of liability protection and the perception it gives, but you’re not a fan of double taxation, an S Corp is a good fit for you. It’s a bit more paperwork, but you get the pass-through taxation benefits and the ability to save on payroll taxes.
Planning to Build a Large Company and Attract Investors
Consider a C-Corp to grow a large business because it is designed for scalability. It can issue different classes of stock, which allows you to offer preferred shares to investors—this is a big deal for attracting venture capitalists or angel investors. While double taxation is a downside, the ability to reinvest profits back into the company without distributing them to shareholders immediately can be a significant advantage, especially in the early stages of growth.
Concerned About Self-Employment Taxes
If self-employment taxes are a big concern for you, then electing S Corps status is a good strategy. In an S Corp, you can pay yourself a reasonable salary and take the remaining profits as dividends, which aren’t subject to self-employment taxes. This can save you a significant amount of money, especially as your business becomes more profitable.
Want Maximum Flexibility and Simplicity
Looking for something straightforward with minimal complexity? An LLC is the best choice for you. It offers strong liability protection, is easier to manage than a corporation, and gives you the flexibility to choose how you want to be taxed. If things change down the road, you can always elect to be taxed as an S Corp or C Corp, giving you the best of both worlds.
Keep the Business Profits in the Company
If your plan is to keep profits in the business to help it grow—perhaps for buying equipment, expanding your office, or hiring new staff—a C Corp could be beneficial. Because a C Corp pays taxes at the corporate level and not all profits need to be distributed to shareholders, you can retain earnings within the company. Just remember, if you retain too much without a legitimate business purpose, you may face the accumulated earnings tax.
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Recap
Choosing between an LLC, S Corp, and C Corp is one of the most important decisions you make for your business. It affects not just how you pay taxes, but also how you manage your business, raise capital, and protect your personal assets.
While LLC is the most flexible option, great for smaller businesses, and if you want simplicity and strong liability protection, It’s adaptable, which makes it a good starting point for many entrepreneurs.
S Corp saves on self-employment taxes, and you’re okay with some additional administrative work. It’s a good fit for businesses that are making consistent profits and want to minimize tax liabilities.
C Corp: Go for this if you’re thinking big—like attracting investors, expanding rapidly, or going public someday. While it’s more complex and has the double taxation issue, it offers the best potential for growth and investment.
Remember, you’re not locked into one choice forever. As your business grows and evolves, you can change your structure. You might start as an LLC and later elect S Corp status or convert to a C Corp if you decide to seek investors. The key is to start with the structure that best fits your needs right now.
This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. . For comprehensive tax, legal or financial advice, always contact a qualified professional in your area. S’witty Kiwi assumes no liability for actions taken in reliance upon the information contained herein.
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