LLC vs. S-Corp vs. C-Corp (The 3-Minute Version)
One question business owners frequently ask is which legal structure is right for their business. So which is best for you? Let’s take a quick look.Sole Proprietorships and Partnerships
There’s really nothing wrong with operating your business as a sole proprietorship or partnership, but you need to be aware that you will have unlimited liability for business debts. In other words, if your business is sued for any reason, the plaintiff will be able to come after your personal assets, not just business assets.
LLC
First, there are no tax advantages (or disadvantages) to forming an LLC. In fact, forming an LLC won’t change a thing for Federal income tax purposes. Single-owner LLCs are taxed just like sole proprietorships, and multiple-owner LLCs are taxed just like partnerships.
You should, however, be aware that forming an LLC might subject your business to additional state taxes. Certain states (California for instance) subject LLCs to “franchise taxes” in addition to a typical income tax.
S-Corporation
S-Corporations have the ability to provide some tax savings as a result of the fact that profits from an S-Corp are not subject to Self-Employment Tax. However, before you’re allowed to distribute any profits, you are required to pay any owner-employees a “reasonable salary.” This salary will be subject to social security and Medicare taxes (which total the same amount as the Self-Employment Tax). As such, the tax savings only take effect once the business has a pretty sizable income.
Also, you should be aware that S-corporations are significantly more complicated from a tax and legal standpoint than LLCs. So if you form an S-corp, know that you’re going to be spending a great many more billable hours with your accountant/attorney.
C-Corporation
Unlike most other business structures, C-corporations are taxable entities. This means that the corporation itself is taxed on its income (as opposed to other structures which simply pass the income along to the owner(s), who are then taxed on it).
If you don’t plan to distribute all of the profits from your business, you might benefit from forming a C-corp and utilizing a strategy known as “income splitting.” The idea is to split the business’s income so that part of it is taxable to the corporation and part of it is taxable to the corporation’s owner(s), thus putting them each in a lower tax bracket than they’d be in if either one was earning all of the income.
The big disadvantage to C-corp taxation is that distributions of profits (known as “dividends”) are subject to double taxation. In other words, the corporation is taxed once on its income, and then the shareholders are taxed upon any dividends they receive.
Also, like S-corporations, C-corporations are more complicated from an accounting/tax/legal standpoint than sole proprietorships, partnerships, or LLCs. As such, C-corp owners tend to incur fairly high legal and accounting costs. some other tax info:
[b]Sole proprietors[/b] are unincorporated businesses. They are also called independent contractors, consultants, or freelancers. There are no forms you need to fill out to start this type of business. The only thing you need to do is report your business income and expenses on your Form 1040 Schedule C. This is the easiest form of business to set up, and the easiest to dissolve. (An LLC with only a single shareholder, a so-called single-member LLC, is taxed as a sole proprietor on a Schedule C.)
[b]Corporations[/b] are incorporated businesses. Every form of business besides the sole proprietor is considered a separate entity, and this often provides a measure of legal and financial protection for the shareholders. The shareholders of corporations have limited liability protection, and corporations have full discretion over the amount of profits they can distribute or retain. Corporations are presumed to be for-profit entities, and as such they can have an unlimited number of years with losses. Corporations must have at least one shareholder.
[b]Partnerships[/b] are unincorporated businesses. Like corporations, partnerships are separate entities from the shareholders. Unlike corporations, partnerships must have at lease one General Partner who assumes unlimited liability for the business. Partnerships must have at least two shareholders. Partnerships distribute all profits and losses to their shareholders without regard for any profits retained by the business for cash flow purposes. (LLCs are taxed as partnerships, unless they choose to be taxed as corporations.)
[b]S-Corporations[/b] have features similar to a partnership. An S-corporation must have at least one shareholder, and cannot have more than 100 shareholders. If any shareholder provides services to the business, the S-Corp must pay that shareholder a reasonable salary. This salary is a separate payment from distributions of profits or losses.
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