Choosing Between LLC, S Corp, or C Corp

Key Takeaways

• Choosing between an LLC, S Corp, or C Corp affects your taxes, ownership flexibility, and ability to raise capital.
• LLCs offer pass-through taxation and flexible management but may face self-employment taxes.
• S Corps provide pass-through taxation with reduced self-employment tax but have shareholder restrictions.
• C Corps allow unlimited shareholders, multiple stock classes, and attract investors, but face double taxation.
• Factors such as business size, growth goals, and investor needs determine which structure fits best.
• Converting between entity types may be possible depending on state laws and IRS requirements.

LLC, S corp, or C corp are a few of your options when starting a new business it is important to select the correct business structure. So, first you need to know the differences. Each type has advantages and disadvantages.

LLCs, C corporations, and S corporations have different benefits and downfalls in terms of stock options and fundraising, taxes, and credibility with clients, customers, and investors. 

Filing a DBA

Below are some key things to note about filing a DBA:

• Filing a DBA allows you to do business in a name other than your own. 
• You usually file it with the county, sometimes with the county tax assessor's office. 
• Partnerships and sole-proprietorships have to use their personal name if they do not file a DBA. 
• A DBA offers no liability protection. 

Implications of Incorporating 

Your corporation or LLC provides partial protection to the directors, officers, and stockholders of a company. On the flip side, if you are personally sued, the LLC or corporation may have protection. Other implications include: 

• Conversion: Each state is different, but most states allow for corporations to convert to a different entity type. 
• Taxation: Individuals are usually taxed at higher rates than corporations. 
• Ownership transfers: LLC and corporation ownership interest is easily transferable. 
• Credit rating: Each corporation has a credit rating totally separate from the owner(s).
• Employee incentives: Incentive stock can be issued to employees as compensation for tenure and work completed. 
• Duration: Both corporations and LLCs have the ability to go on indefinitely, as long as they follow state, county, and federal laws. 
• Raising Capital: Corporations have the ability of raising capital through stock sales and convertible debt issuance. 

Comparing LLCs, S Corps, and C Corps

When deciding whether to form an LLC, S Corp, or C Corp, understanding how each structure impacts ownership, taxation, and operations is key. Each offers unique benefits depending on business goals:

Each business structure affects how profits are taxed and how ownership is distributed. For example, LLCs are best for simplicity and flexibility, while C Corporations suit companies expecting significant outside investment. S Corporations often appeal to small businesses that want corporate credibility but prefer pass-through taxation.

Information on C Corporations

A C corporation is a general corporation, and C corporation and corporation are used interchangeably. Your company is automatically a C corp when you form it. Incorporating makes the business a separate entity. When corporate profits or dividends are issued, the owners are responsible for paying personal taxes on the money they receive. 

If the following apply to you, you may want to form a C corporation: 

• You want to use venture capital financing.
• You want the owners to have flexibility with profit shares; you want to keep your earnings in the business.
• You want business earnings flexibility. 
• You would like to provide employees with fringe benefits, like health care.
• You want the ability to easily sell the company.
• You want to issue employee accounts for travel and entertainment. 
• You want to offer employees stock options. 
• Your company will own property. 
• You wish to lower your tax audit risk. 

Advantages and Disadvantages of a C Corporation

Advantages

• Investor appeal: C Corps can issue multiple stock classes, making them ideal for venture capital or angel investment.
• Perpetual existence: Ownership changes do not dissolve the corporation.
• Tax-deductible benefits: Health insurance, retirement plans, and certain employee benefits can be deducted as business expenses.
• Easier transfer of ownership: Stocks can be bought and sold freely.

Disadvantages

• Double taxation: Profits are taxed at both the corporate and shareholder levels.
• Administrative complexity: Requires formalities such as annual meetings, bylaws, and minutes.
• Cost of compliance: More expensive to maintain due to stricter reporting and legal obligations.

C Corporations are typically best for larger or fast-growing businesses that want to raise funds publicly or through private equity. Startups planning to seek institutional investors or go public often choose this structure.

Information on S Corporations 

Regardless of what entity type your business is, you have to file IRS Form 2553 in order to elect S Corporation status. The requirements of Form 2553 are a bit difficult to follow, but you must turn it in following the guidelines below determine what tax year it applies to:

• Before the 15th of March, election may be made for the current year. 
• Anytime the year before you want to be taxed as an S corporation. 
• If you turn it in after the 15th of March, it applies to the next tax year. 

In some states, you also have to file for S corporation on the state-level after you form your corporation. Taxation is the biggest difference between S and C corporations. The only taxation for S corporations is at the shareholder level. The S corporation may be right for you if:

• You wish to receive the benefits of a corporation and retain pass-through taxation benefits, too. 
• You want to lower Social Security and Medicare taxes and offer flexible salaries for your employees. 
• You are looking for flexible accounting options. 
• You wish to lower your audit risk.

Advantages and Disadvantages of an S Corporation

Advantages

• Pass-through taxation: Profits and losses flow directly to shareholders, avoiding double taxation.
• Lower self-employment tax: Owners can receive a “reasonable salary” and take additional profits as distributions taxed at a lower rate.
• Credibility: Offers corporate structure while maintaining tax efficiency.
• Asset protection: Limited liability shields personal assets from business debts and lawsuits.

Disadvantages

• Ownership restrictions: Limited to 100 shareholders who must be U.S. citizens or residents.
• Single class of stock: Limits flexibility in profit distribution.
• More IRS scrutiny: The “reasonable compensation” requirement can trigger audits.

S Corporations are popular among small business owners seeking the tax advantages of an LLC with the formal structure of a corporation. However, businesses anticipating foreign investors or multiple stock classes may prefer a C Corp.

Information About LLCs

Forming an LLC gives you the best of both worlds. You receive the limited liability protection as well as pass-through tax benefits. Business expenses and income are included on your personal Form 1040. The LLC is probably the right structure for you if: 

• You think you will have losses for the first two years. 
• You want flexibility with accounting. You want management structure flexibility. 
• Your business will own property. 
• You want to minimize the requirements you must adhere to. 
• You want flexible profit and loss sharing among members.

Pros and Cons of an LLC

Advantages

• Tax flexibility: LLCs can elect to be taxed as a sole proprietorship, partnership, or corporation.
• Simplicity: Fewer compliance requirements compared to corporations.
• Limited liability: Protects members’ personal assets from business debts.
• Flexible ownership: No restrictions on the number or type of members.

Disadvantages

• Self-employment taxes: Members may pay higher taxes on earnings compared to S Corp shareholders.
• Limited growth potential: Cannot issue stock, which may limit investor interest.
• Varied state laws: LLC regulations and filing fees differ by state.

An LLC suits small business owners who want operational flexibility and liability protection without corporate formalities. It’s also an excellent starting point for entrepreneurs who may later convert to an S or C Corporation as the business grows.

How to Choose Between an LLC, S Corp, or C Corp

When selecting your business structure, consider these key factors:

1. Business Goals:
   • Choose an LLC for operational flexibility and simple taxation.
   • Choose an S Corp for modest growth and tax savings on self-employment income.
   • Choose a C Corp if you plan to raise venture capital or go public.
2. Tax Considerations:
   • LLCs and S Corps avoid double taxation, but S Corps can reduce self-employment taxes through distributions.
   • C Corps pay corporate taxes and shareholders pay taxes on dividends.
3. Ownership Restrictions:
   • LLCs allow unlimited members.
   • S Corps are limited to 100 U.S.-based shareholders.
   • C Corps allow unlimited shareholders, including foreign investors.
4. Future Conversion:
   • LLCs can elect S Corp taxation or convert to a corporation as they grow.
   • Converting from an S Corp to a C Corp is common when raising capital.

Selecting the right entity can have long-term financial and legal consequences. Entrepreneurs often consult with an attorney or tax professional to evaluate which structure best aligns with their goals.

Frequently Asked Questions

1. What’s the main difference between an LLC, S Corp, and C Corp? LLCs and S Corps offer pass-through taxation, while C Corps are taxed twice—once at the corporate level and again on dividends.

2. Can an LLC become an S Corp or C Corp later? Yes. LLCs can elect S Corp tax status using IRS Form 2553 or convert to a C Corp for better investor access.

3. Why do startups often choose a C Corporation? C Corps allow unlimited shareholders, multiple stock classes, and easier equity investment, making them ideal for raising venture capital.

4. Which business type minimizes self-employment taxes? An S Corporation can reduce self-employment taxes by paying owners a reasonable salary and distributing remaining profits.

5. Do all states treat S Corps the same? No. Some states do not recognize S Corporation status and may tax them like C Corporations. Check your state’s tax regulations before filing.

With all of the different benefits and liabilities of each type of corporation, it is a good idea to consult a professional who can help you understand how to maximize the benefits and decrease your liability. If you need help with an LLC, S corp, or C corp, 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.