C Corp Vs LLC Tax Advantages: Everything You Need to Know
Understanding C Corp vs. LLC tax advantages is crucial when deciding how to incorporate your business. 3 min read
What Is Incorporation?
C corp vs. LLC is one of the most important considerations for new entrepreneurs. Each of these business structures is treated differently by the Internal Revenue Service (IRS) and offers different tax advantages. Incorporating a business means that your company is transformed from a sole proprietorship or partnership into a separate legal entity.
The two most common small business entities are:
- A corporation
- A limited liability company (LLC)
Both structures provide increased credibility and protection from personal liability. Each also has unique advantages and disadvantages, so it's important to decide, which business structure is most appropriate for your specific company. This will have implications for taxation as well as your company's continued growth and success.
Limited Liability Company (LLC)
An LLC combines features of a partnership, including flexibility and tax benefits, with those of a corporation, including limited liability. Limited liability means that your personal assets cannot be seized as a result of unpaid business debt or a legal action against your company. Unlike corporations, which must adhere to specific management requirements, LLCs allow for an informal, flexible management structure.
If you form an LLC, you will be subject to pass-through taxation, which means that you report business income and loss on your personal tax return. LLCs with just one owner are taxed in the same way as sole proprietorships, while LLCs with several owners are subject to partnership taxation.
If you are a small business owner who wants the benefits of limited liability, appreciates management flexibility, and has no plans of attracting capital from investors, an LLC might be the right entity for your company.
To establish an LLC, you must:
- File articles of organization with your state.
- Post a public notice of the company's formation in the local newspaper.
- Pay state filing fees.
Although an LLC is not required to have an official operating agreement, doing so provides a structure that delineates membership percentages and rights and is recommended if your LLC has more than one owner.
Single-member LLCs are allowed in all states and are automatically subject to pass-through taxation unless you elect to be taxed as an S or C corporation. With an S corporation, you can avoid the 15.3 percent self-employment tax on business income by paying yourself a salary and treating remaining profits as distributions. Since these distributions are not taxed as self-employment income, you'll owe less taxes on your business income. To elect corporate tax status for an LLC, you'll need to submit the appropriate IRS forms.
LLCs are subject to fewer formal requirements compared to corporations. You do not need to hold annual member meetings or issue stock shares to owners. However, you must file an annual report with the Secretary of State. You can detail additional requirements in your LLC operating agreement.
While LLCs can raise money by selling investors a share of ownership, some investors prefer stock. Unlike a corporation, an LLC is a privately held business and cannot go public, resulting in a lower return for investors.
S and C Corporations
Like an LLC, an S corporation is considered a pass-through taxation entity. A C corporation issues stock and is owned by shareholders. If you plan to make your business public down the road, if you raise substantial funding from outside investors, or if you own a high-liability business such as health care or construction, forming a C corporation is likely the right choice.
A C corporation is taxed as a separate entity and is subject to double taxation. This means that not only are you taxed on profits when they are received by the company, but also when they are distributed as dividends. For this reason, some C corporations engage in income-splitting, making some business income taxable to the company and some to the owners, which lowers the taxable income for both.
C corporations are more financially and legally complex than LLCs, sole proprietorships, and partnerships. This means you'll likely pay more for accounting and legal advice. With an S corporation, you can deduct business losses on your personal tax return. This structure also allows you to save on self-employment and FICA taxes (Medicare and Social Security).
If you need help with deciding which business entity is most advantageous for your specific situation, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.