Know the differences between C corpvs. S corpvs. LLC before forming your business. A corporation operates as a separate and distinct legal entity from its owners. This means the owners, also referred to as shareholders, are personally protected against liability for the corporation’s debts and obligations. Similarly, an LLC, or limited liability company, also provides personal liability protection for its owners, also referred to as members.

LLC: An Overview

The LLC has many unique features and characteristics, most of which provide several advantages for operating as this type of business structure. As previously noted, the LLC provides limited liability for its members, meaning that their personal assets cannot be affected in the event that creditors file a legal action based on the LLC’s debts.

The LLC also provides a flexible management structure, meaning that the members can choose to either manage the LLC themselves or hire an outside third-party manager. In addition, the members can also appoint another member to act as the manager of the business.

The LLC operates as a pass-through tax entity, as the profits and losses of the business are reported on the members’ personal tax returns. If, however, you operate a single-member LLC, then you will be required to report taxes as a sole proprietorship. Therefore, all of the company’s income is input on your personal tax return (Schedule 1040).

An LLC might be the best choice for you in the following circumstances:

  • Your business expects some sort of loss in the first few years of operating
  • Your business owns real estate
  • You want flexibility in terms of management
  • You want to reduce corporate formalities

Corporation: An Overview

Some of the many characteristics and features of a corporation include:

  • Personal liability protection
  • Preferred business structure for investors
  • Preferred business structure for an Initial Public Offering (IPO)
  • Recognized outside of the U.S.
  • Requires a significant amount of paperwork during the formation process

When a business incorporates, it automatically defaults to a C corporation. Therefore, if the business wants to be taxed as an S corp, then it must submit a request to the Internal Revenue Service (IRS).

S Corp: An Overview

After you’ve formed your corporation, you can choose to be taxed as an S corp if you meet the IRS guidelines for doing so. You’ll need to fill out Form 2553, indicating you want to be identified as a subchapter S corp. Most S corps are small businesses that have fewer annual profits, totaling no more than $5 million, generally.

A lot of new businesses choose between either an S Corp or LLC; the S corp shares similarities with the LLC. Particularly, the S corp operates as a pass-through tax entity in the same way as an LLC. Therefore, the S corp won’t pay corporate income taxes. All funds flowing in and out of the business will be reported on the shareholders’ personal tax returns.

The S corp might be the best choice for your business if:

  • You want to share certain operational traits of the C corp but want to operate as a pass-through tax entity
  • You want flexibility in terms of setting salaries for employees and shareholders to minimize taxes (Social Security and Medicare)
  • You want to use a non-accrual method of account. C corps are generally required to use this method whereas S corps can use a cash method of accounting (unless they have inventory)

S corps can have no more than 100 shareholders, all of whom must be U.S. citizens or permanent residents. Such shareholders cannot be other business structures, i.e., C corps, S corps, LLCs, partnerships, or trusts. S corps can offer only one class of stock, unlike the C corp that can offer a variety of classes of stock to thousands of investors.

If you are a shareholder of an S corp and you conduct a lot of work for the business, then you must be paid a reasonable salary. Therefore, you cannot simply receive dividends as a form of salary, as you must receive some sort of reasonable compensation for the work being done. This compensation is subject to self-employment tax.

If you need help learning more about forming a C corp, S corp, or LLC, 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.