One of the most important decisions you’ll need to make when starting a business is deciding on the entity type that will help you reach your business. Ultimately, your decision will depend on various factors such as control, taxation, liability, and the ease of raising capital. Every business structure comes with its own set of advantages and disadvantages. The following guide will take a closer look at S corp vs. C corp vs. LLC.
|S corp||S corps offer personal liability protection, ensuring that the personal assets of owners cannot be taken to pay off business debts and obligations.||S corps are pass-through entities. So all income is passed through to the owners to report on their personal tax returns. There is no corporate tax paid by the S corps.||A board of directors and officers must be elected. They are responsible for managing day-to-day operations using the corporate bylaws as their guide.|
|C corp||C corps have limited liability protection, so personal assets are off limits in the event of business debts and lawsuits etc.||C corps experience double taxation. They are taxed at the corporate level and again on the individual level as shareholders must report income on their personal tax returns.||A board of directors and officers must be elected. They are responsible for managing day-to-day operations using the corporate bylaws as their guide.|
|LLC||Provides personal liability protection so that members are only responsible for debts, losses etc based on the financial investment they’ve put into the company.||Liable for income and self-employment taxes. Considered “disregarded entities,” income taxes are passed-through to members.||Must file Articles of Organization, relevant tax returns, annual reports and renew licenses and permits.|
What is an S corp?
S corporations offer pass-through taxation, a huge benefit for small business entities looking to save on taxes. This is because S corporations are not liable for federal income tax, and the profits from the company are taxed at the individual level. Therefore, shareholders must meet certain criteria to ensure that corporate losses are offset by income from other sources.
Additionally, S corporations receive the same limited liability protection of default corporation status as a separate entity.
However, S corporations have limitations, such as the number of shareholders they can have, which may be a drawback for corporations that want to go public.
Additionally, ownership is limited mostly to individuals, and they must also be permanent residents of the United States or citizens of the US.
Alternatively, estate and tax-exempt organizations, as well as some domestic trusts, may also form S corporations.
S corp benefits
- Protection of assets: A huge benefit of S corporations is the personal, limited liability protection that it affords owners. Therefore, owners’ personal assets are off-limits to creditors when paying off business debts and obligations.
- Pass-through taxation: S corporations enjoy pass-through taxation, also known as flow-through taxation benefits. This means that the profits and losses of the corporation owners are to be reported on their individual tax returns. Therefore, the corporation is not taxed at the corporate level and avoids double taxation.
- Dividend and salary payments: S corporations may receive both salary and dividend payments from the company, resulting in lower tax bills.
- Ease of conversion: An S corporation may choose to elect a C corporation status at any point by simply contacting the IRS.
S corporation drawbacks
- Membership limitations: One of the restrictions of S corporations is that they are not allowed to have more than 100 shareholders compared to other business structures, like C corporations that can have any number of members.
- Allocation of profits and losses: When compared to how an LLC can allocate losses and profits, the requirements are far more stringent with S corporations. The profits and losses must be allocated among the shareholders and depend on the ownership percentage.
- Corporation formalities: Corporations have strict formation and ongoing compliance requirements. The requirements are far more stringent when compared to forming a sole proprietorship, general partnership, and LLC.
- S Corp status: To elect the S Corp status, you must meet certain requirements before being approved to operate and be taxed as an S corporation.
Check out our guide on How to Start an S Corp.
What is a C corp?
C corporations are the default corporation structure making it the most common corporate tax status. C corporations, like S corporations, also get their name from the subchapter of the IRC or Internal Revenue Code under which they are taxed.
Tax requirements are the differentiating factor between C corps and S corps. C corps are liable for corporate income tax with a federal return required by the IRS or Internal Revenue Service. After that, shareholders are liable for income tax on their share of the dividends. This is called double taxation since taxes are required on both the corporate and individual levels.
Unlike the S Corp, C Corp owners or shareholders cannot write off corporate losses to balance out other income on personal income statements.
However, one of the reasons C corps are desirable by many entrepreneurs is that there are no limitations on who can own shares.
Consequently, businesses within and outside the US can hold ownership of the C Corp.
Additionally, C corps do not limit the number of shareholders as S corporations do. All C Corp shareholders are also given full liability protections of any corporation.
C corporation benefits
- Limited liability: When you form a C corporation, the IRS considers you a separate legal entity, meaning the business’s assets are distinct from yours. So your personal assets are off-limits in case lawsuits are brought against the corporation.
- Better fringe benefits: C Corporation owners command more respect in B2B relationships with customers, clients, suppliers, and vendors. This is because C corporations signal that they are serious about their business since they have gone through the strict and detailed formation process.
- Perpetual existence: The existence of your C corporation is completely independent of any board member, shareholder, or individual owner. In the event of any shareholder dying, the business itself will continue.
- Tax advantages: One of the tax advantages that the C corporation enjoys is that shareholders may be given a salary even if they’re not involved in the day-to-day running of the business. The salaries are then claimed as business expenses which is a huge tax advantage in reducing corporate income tax.
C corporation drawbacks
- Double taxation: Double taxation is the biggest disadvantage of forming a C corporation. Double taxation means the business is taxed at the corporate tax rate, and then the shareholders are taxed again at the individual level.
- Complexity: A corporation is far more complex to run than an LLC in terms of operation and management structure. Certain formalities cannot be avoided if you want to have your company in good standing. Minutes of meetings must be recorded, annual shareholder meetings must be held, and proper notice must be given in terms of any changes in the company.
Read more about corporations.
What is a limited liability company (LLC)
A limited liability company LLC is considered a separate and legal business entity formed under state laws. A single business owner may form an LLC and, in this case, is considered a single-member LLC. However, if there is more than one member, it’s called a multi-member LLC. Multi-member LLCs also have the option to have the company managed by someone outside of the company or by the LLC members. Ultimately, the Internal Revenue Service considers LLCs separate legal entities from its members, and therefore they enjoy the same tax-paying benefits.
- Personal asset protection: LLCs appeal to entrepreneurs and small business owners since they provide personal asset protection. This means that if the company has any debts, obligations, or even losses brought against them, members’ personal assets cannot be used to pay off creditors.
- Ownership flexibility: LLCs can be owned by individuals, corporations, partnerships, foreign entities, and trusts.
- Credibility: LLCs have more credibility with financial institutions, vendors, clients, and suppliers since they are seen as more formal business structures when compared to general partnerships and sole proprietorships.
- Pass-through taxation: While LLCs are not the only business structure that enjoys pass-through taxation, it is one of the main benefits of forming an LLC.
- Compliance requirements: LLCs have fewer compliance requirements when compared to business structures like corporations.
- Management structure: LLCs have a lot of visibility regarding how the company is managed. For one, the LLC members do not need to hire a manager and can run the day-to-day operations between themselves. However, if the members have little time or the capacity to manage the business, an individual from outside the company may be hired to handle day-to-day operations.
- Transfer of ownership: All LLCs must create an operating agreement before beginning operations, as this will simplify and streamline a lot of processes that can become an issue later on. For example, LLCs can only bring on new members with all existing members agreeing. However, with an operating agreement in place, this issue can be avoided.
- LLC costs: It costs far more to form an LLC than a sole proprietorship or a general partnership. Additionally, ongoing filing and annual fees are associated with limited liability companies.
Read more about LLC types here.
Should I start an S corp vs. C corp vs. LLC?
Deciding which business structure is right for you can be challenging if you don’t know the benefits and drawbacks of each entity type. C corporations are a popular corporation structure and come with their own set of advantages and advantages. The same can be said for all S corporations since they have tax advantages; however, they come with limitations in other areas. Limited liability companies as well offer business owners personal liability protection, but there are some drawbacks to this type of structure. So you need to look at several factors before making a well-informed decision.
S corp vs. C corp vs. LLC taxes
There are quite a few similarities and an equal amount of differences in how an S Corp, C Corp, and LLC are taxed. So let’s take a closer look at that below.
S corp taxes
- For tax purposes, S corps are regarded as pass-through entities meaning that the shareholders or owners are responsible for reporting their share of the business’s losses and profits when submitting their personal tax returns.
C corp taxes
- C corporations are subject to double taxation. This is because they are liable for both corporate income tax as well as personal income tax.
- The corporation itself must submit a corporate income tax return, while the shareholders must also submit individual income tax returns on profits that they’ve received from the C corporation.
- One of the only ways to not experience double taxation is to elect S corporation status.
- Once you have S corporation status, you will avoid being taxed at the corporate level, as you’re only liable for personal income tax on the profits received by the S corp.
- LLCs are taxed differently from other types of entities. This is because the losses and profits from the company pass through to the business and are reported on the owner’s personal tax returns. This is considered pass-through taxation, and LLCs are considered pass-through entities.
- LLCs’ profits or income are ultimately taxed at the personal tax rate and not at the corporate level.
- If there’s more than one member in the LLC, it’s regarded as a multi-member LLC; therefore, each member in the company must report profits and losses on their personal tax return.
- LLCs are liable for self-employment taxes.
S corp vs. C corp vs. LLC: Formal requirements
Different business structures have different formation requirements. So is the case with S corps, C corps, and LLCs.
Formal requirements for S corps
- You need to elect S Corp status with S corporations by filing IRS Form 2553. Additional paperwork may be required depending on your state.
- Additionally, S corporations need to file Articles of Incorporation or Articles of Organization, elect a Board of Directors and officers, appoint a registered agent, and create corporate bylaws.
Formal requirements for C corps
- C corporations need to file Articles of Incorporation or Articles of Organization, elect a Board of Directors and officers, appoint a registered agent, create corporate bylaws, hold annual meetings, and record minutes of meetings.
Formal requirements for LLCs
- LLCs are usually encouraged to follow the S corporation guidelines and are not obligated to do so from a legal standpoint. However, like corporations, LLCs must conduct annual shareholder meetings and adopt corporate bylaws.
- Additionally, they need to compile an operating agreement laying out the terms and conditions and the roles and responsibilities of all LLC members.
S corporations, C corporations, and LLCs also have ongoing compliance requirements that vary based on each state; however, they must be complied with to keep your business in good standing. Therefore, to remain compliant, you’ll need to adhere to the legal requirements of running your business, which include paying the relevant filing fees, submitting annual reports on time, and submitting Medicare and Social Security business taxes.
S corp vs. C corp vs. LLC: Management structure
Different business structures will have different management structures. Let’s have a closer look at them below:
S corp management
- S corporations have a Board of Directors and officers in charge of running the day-to-day operations.
C corp management
- C corporations have a Board of Directors and officers in charge of running the day-to-day operations.
- With limited liability companies, they can hire a manager outside of the company or have the business members run the activities and operations.
- In the case of LLCs, it’s important to have an operating agreement drawn up to ensure that all organization members are on the same page regarding how the business will be operated and managed.
S corp vs. C corp vs. LLC: Ownership structure
The ownership structure between S corps, C corps, and LLCs has differences. Let’s have a closer look at them below:
S corp ownership
- S corporations are limited to the number of shareholders they can have, and the shareholders also need to be US citizens or any individual holding a US passport.
- You can have up to 100 shareholders in an S corp.
C corp ownership
- C corps do not come with any ownership limitations, and they can have an unlimited number of shareholders.
- LLCs have not been regulated in the same manner that corporations were.
- The formal requirements and ongoing compliance and maintenance are much more lenient for LLCs than any other type of business structure.
When deciding on the best business entity type for you, there is no one-size-fits-all option. Therefore, your decision should be based on several factors, such as your business goals, tax benefits you’d like to enjoy, and the flexibility of ongoing maintenance and compliance. Before making the final decision, consider the fact that other business structures are out there. Some popular entity types are sole proprietorships, nonprofits, and partnerships.
S corporations pay lower taxes than LLCs. This is because LLCs are liable for high self-employment taxes on the net earnings from the company, whereas when you elect S corp status, it allows you to pay only those taxes on the salary you take from your company.
The three main types of corporations include the C Corporation, the default corporation structure, and is subject to double taxation. The S corporation structure avoids double taxation and reduces self-employment taxes. The nonprofit corporation structure is formed for the greater good of society and is not intended to generate profits for owners or shareholders.
Forming an LLC comes with various advantages, including personal liability protection, flexible taxation, ownership, management flexibility, and relatively simple formation requirements.
One of the primary differences between a C corp and an LLC is that while LLCs are pass-through entities, they don’t file taxes on behalf of the business but report income on their personal tax returns. C corporations, on the other hand, are liable for corporate income tax; therefore, the corporation must file its tax returns.
Sole proprietors are not considered legal entities and have no existence apart from the owner called the sole proprietor. Therefore, sole proprietors must report all business income on their personal tax returns.