Key Takeaways

  • The main distinction among LLCs, S Corps, and C Corps lies in tax treatment, ownership rules, and management flexibility.
  • LLCs provide simplicity, pass-through taxation, and operational flexibility—ideal for small business owners seeking liability protection without corporate formalities.
  • S Corps offer pass-through taxation and potential self-employment tax savings, but have restrictions on ownership and stock classes.
  • C Corps allow unlimited shareholders, multiple stock classes, and are favored by investors, but face double taxation.
  • Converting between these structures requires IRS filings, such as Form 2553 for S Corp election.
  • Your best choice depends on growth goals, number of owners, and long-term funding strategy.
  • You can find an attorney on UpCounsel to help you form or convert your business entity properly.

Whether choosing an LLC, S Corp, C Corp, or some combination of these business entity structures for your business, you'll want to understand the advantages and disadvantages of each and how they work. 

LLCs and Corporations

Corporations and limited liability companies (LLC) both provide a level of liability protection to the owners or shareholders of the business. They protect the personal assets of company members from creditors and others if the business faces financial or legal trouble. All of the personal finances and business finances are kept separate with LLCs and corporations. Both of these entity types are considered legal throughout the United States. 

LLCs enjoy more flexibility than corporations when it comes to their management structures and reporting taxes.

Corporations are better options for companies looking for outside investors and stock market action, plus they are internationally recognized entities. 

Key Differences Between LLC, S Corp, and C Corp

Choosing between an LLC, S Corp, or C Corp depends largely on your business’s goals for taxation, liability, and growth.

LLC (Limited Liability Company)

  • Offers flexibility in management and taxation.
  • Members report profits and losses on personal tax returns.
  • Avoids double taxation but may face self-employment tax on all earnings.
  • Easier to operate, with fewer formalities and no stock issuance.

S Corporation

  • Operates as a pass-through entity, meaning income flows to shareholders’ personal tax returns.
  • Allows owners to save on self-employment taxes by classifying part of their income as salary and part as distributions.
  • Limited to 100 shareholders, all of whom must be U.S. citizens or residents, and can issue only one class of stock.

C Corporation

  • A separate legal entity that pays corporate income tax on profits and shareholders pay again on dividends (known as double taxation).
  • Can have unlimited shareholders and multiple stock classes, making it attractive for investors and venture capital funding.
  • Provides greater flexibility for expansion, stock options, and employee benefits.

What Is an S Corp?

A single-member LLC can opt to be viewed as corporation or sole proprietorship by the Internal Revenue Service (IRS) for taxation. If the LLC takes on the sole proprietorship or partnership classification, the members (or owners) of the business are required to report the company's income on their personal tax returns. 

Multi-member LLCs can be treated as corporations or partnerships. If an LLC chooses to be taxed as a corporation, they can choose either S Corp or C Corp status. 

S Corps are pass-through business entities, meaning that the profits and losses of the company pass through the to its owners and are therefore only taxed once on the personal income tax returns of the owners. C Corps are not treated as pass-through entities.

Tax Treatment and Compliance Differences

The tax implications among LLCs, S Corps, and C Corps are one of the most significant decision factors.

  • LLCs are taxed as disregarded entities or partnerships by default, but can elect S Corp or C Corp status for tax purposes.
  • S Corps pass income through to shareholders, avoiding corporate-level tax. However, owners must pay themselves a reasonable salary, subject to payroll taxes.
  • C Corps are taxed at a flat 21% corporate tax rate, with shareholders taxed again on dividends, though they can deduct a wider range of business expenses and fringe benefits.

Compliance and Reporting:

  • LLCs require less paperwork, with flexible recordkeeping.
  • S Corps and C Corps must hold annual meetings, maintain minutes, and file annual reports with the Secretary of State.
  • Both corporation types are subject to stricter governance and shareholder structure rules.

C Corps and S Corps

Owners of LLCs that choose either C Corp or S Corp status will still be required to report the company profits and losses on their personal tax returns. But a C Corp will also be taxed on its business income, so the profits of the company are taxed twice. 

S Corps are not allowed to have over 100 members or shareholders, and all of these individuals have to be citizens of the United States or resident aliens and not other business entities. 

Ownership and Stock Structure

Ownership flexibility differs greatly among an LLC, S Corp, and C Corp.

  • LLCs can have any number or type of members, including individuals, corporations, or other LLCs.
  • S Corps are limited to 100 individual shareholders, all of whom must be U.S. citizens or residents.
  • C Corps have no limit on shareholders and may issue common and preferred stock, which is essential for raising venture capital.

Investment Considerations:If your business plans to seek outside investors or go public, forming a C Corp is typically the best path due to its ability to offer multiple stock classes and attract venture funding.In contrast, LLCs and S Corps are ideal for small or medium-sized businesses focused on simplicity and direct profit sharing.

Forming a C Corp, S Corp, or LLC

The LLC business structure itself has no effect on how a business entity is taxed. When it comes to taxation practices, an LLC is either a sole proprietorship, partnership, or corporation. LLCs do not have their own tax identity. 

Whether a business owner is looking to form an LLC, S Corp, or C Corp, they will need to file formation documents with the Secretary of State office in the state where they plan to conduct business. Corporations file articles of incorporation and LLCs file articles of organization. 

When an LLC chooses to incorporate, they are automatically classified as a C Corporation (C Corp).

C Corps are taxed as their own business entities, so the profits and losses of the company are taxed through the business itself, not its owners. 

However, any dividends or profits distributed to the shareholders or owners of the company are also taxed on the individual income tax returns of the recipients. This means that the company's income is taxed twice. 

For this reason, business owners don't usually choose the C Corp structure for smaller companies. 

You might choose the C Corp structure for your business if:

  • You need outside investors (non-member investors).
  • You want owners to have flexibility when it comes to sharing profits.
  • You hope to grow a larger company.
  • You want flexibility in your profit distributions for better tax-planning.
  • You want to be able to offer large health, medical, and fringe benefits to owners and employees.
  • You want the company to be able to own property.
  • You want to have the option to offer employees stock options.

If you've incorporated your LLC, you might decide to opt for S Corp status if you want to benefit from a pass-through entity structure while also enjoying the benefits of a corporate structure. 

LLCs can also choose to remain unincorporated and treated as a disregarded entity for taxation purposes. The assets of LLC members are protected from liability with the LLC structure just like with corporations, but they don't have as many options for larger company growth and stock. 

How to Choose the Right Entity

When deciding between an LLC, S Corp, or C Corp, consider your business objectives, tax strategy, and growth potential:

  • Choose an LLC if you want simple setup, flexible management, and pass-through taxation.
  • Choose an S Corp if you want pass-through taxation and the ability to reduce self-employment taxes.
  • Choose a C Corp if you plan to raise venture capital, issue stock, or reinvest profits into the company.

Key Formation Steps:

  1. Choose a unique business name and verify availability with your Secretary of State.
  2. File the required formation documents — Articles of Organization (LLC) or Articles of Incorporation (C/S Corp).
  3. Obtain an EIN from the IRS.
  4. Draft an operating agreement (LLC) or corporate bylaws (C/S Corp).
  5. File Form 2553 to elect S Corp tax status (if applicable).
  6. Maintain compliance by filing annual reports and paying state franchise taxes if required.

Frequently Asked Questions

  1. Which is better for small businesses — LLC, S Corp, or C Corp?
    An LLC is generally best for small businesses due to its flexibility and simple tax structure, while S Corps can provide additional tax savings for certain owners.
  2. Can an LLC be taxed as an S Corp?
    Yes. An LLC can elect to be taxed as an S Corp by filing IRS Form 2553, allowing pass-through taxation with potential savings on self-employment taxes.
  3. Why do larger companies prefer C Corps?
    C Corps can issue multiple stock classes and attract investors, making them ideal for scaling, raising venture capital, or going public.
  4. What are the disadvantages of an S Corp?
    S Corps have strict eligibility rules, limited ownership, and must pay owners a “reasonable salary,” subject to payroll tax scrutiny.
  5. Can I switch from an LLC to a C Corp later?
    Yes. Businesses often start as LLCs and later convert to C Corps when seeking investors or expansion. The process requires filing conversion documents and IRS updates.

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