LLC vs C Corp: Everything You Need to Know
An LLC is a business entity that is legally separate from its owners and a C Corporation refers to any corporation taxed separately from its owners.5 min read
2. Similarities of an LLC and an S Corp
3. Differences Between an LLC and an S Corp
4. Why Start an LLC?
5. Why Start an S Corp?
6. Qualifying for S Corporation Status
7. Tax Benefits
8. S Corp Or LLC
Updated October 16, 2020:
LLC Versus C Corp: What Is It?
An LLC is a business entity that is legally separate from its owners, who are known as "members." An LLC can have one member or many members.
A C Corporation refers to any corporation taxed separately from its owners. Unlike S Corporations, taxing of C Corporations occurs twice, once on the earnings and again on the salaries of the owners.
Similarities of an LLC and an S Corp
LLCs and S Corps have several similarities:
- Limited liability protection. In both an LLC and an S Corp, owners are not personally responsible for business debts or liabilities.
- Separate entities. LLCs and S Corps are separate legal entities formed through a state filing.
- Pass-through taxation. Both usually receive the pass-through tax, meaning they are not double taxed.
- Ongoing state requirements. Both LLCs and S Corps are subject to state-mandated administration filings, such as filing annual reports and paying the necessary fees.
Differences Between an LLC and an S Corp
Ownership. The IRS restricts S Corporation ownership but does not do that for LLCs. IRS restrictions include the following:
- While LLCs can have an unlimited number of members, S Corps cannot have more than 100 shareholders.
- Non-U.S. citizens or residents can be members of LLCs, but S Corps cannot have shareholders that are non-U.S. citizens or residents.
- C Corporations, other S Corporations, LLCs, partnerships, or trusts cannot own S Corporations.
- LLCs are can have subsidiaries without restriction.
Ongoing formalities. S Corporations have more internal formalities. It is recommended, but not required, for LLCs to follow those same internal formalities:
- It's required that LLCs adopt bylaws, issue stock, hold initial and annual directors and shareholders meetings, and keep meeting minutes in the corporate records.
- It's recommended that LLCs adopt an operating agreement, issue membership shares, hold and document annual member meetings or manager meetings if the LLC is manager-managed, and document all major company decisions.
Differences in management. Owners of an LLC can choose to have the owners or the managers manage the LLC. When owners manage an LLC, it is similar to a partnership. If it's run by managers, it closely resembles a corporation. The owners will not be part of the daily decision-making.
- S Corps have directors and officers. The board of directors oversees corporate affairs and handles major decisions but not daily operations. Directors elect officers who manage daily business affairs.
- Existence. An S Corporation exists indefinitely. An LLC on the other hand often has a dissolution date on the formation documents. Certain events like death or withdrawal of a member, can cause the dissolution of an LLC.
- Transferability of ownership. S Corporation stock is freely transferable. LLC ownership is not usually freely transferable. It's a requirement to first receive approval from other members.
- Self-employment taxes. S Corporations may have preferable self-employment taxes compared to the LLC. You treat the owner of an S Corp as an employee and pay them a salary. They pay taxes on that salaried amount. Corporate earnings after payment of the salary are then treated as unearned income that is not subject to self-employment taxes.
Why Start an LLC?
Every year, more people start LLCs than S-Corps. An LLC is more appropriate for business owners whose biggest concern is having flexibility in their business management. Limited liability companies are also easier to start and to run than corporations:
- LLCs give liability protection to their members. This means your personal assets are protected against debts, losses, and any court rulings against your business.
- LLCs receive "pass-through" tax. This means that taxes are much easier, but it also means you will pay those taxes on yyour personal tax return.
- LLCs give greater flexibility. Management structures for corporations are much more rigid than those of an LLC. With an LLC you can choose whatever management structure you want.
- LLCs have far less paperwork. They are easier to run and keep compliant with federal, state, and local laws.
Why Start an S Corp?
Most of the largest and most profitable companies in the country are corporations. There are several advantages to starting an S Corp:
- S Corps protect their shareholders from liability. The only money at risk is whatever shareholders invested in the S Corporation. Your personal assets are protected.
- S Corporations are not taxed, but shareholders are. Similar to LLC, S Corps receive the "pass-through" tax breaks.
- S Corps seem more legitimate. Investors usually view corporations as more permanent than LLCs, making them more likely to invest.
- S Corporations have a more rigid management structure. S Corporations have strict rules for how to stay compliant and who can vote on corporate practices. These rules give the owners a clear path to follow.
- S Corporations need more administration. The extra paperwork gives owners a concrete record of their decisions and proof that they have acted in the best interest of the company. These documents are valuable for tax and liability reasons.
- S Corporations can sell stock. While LLCs can only sell interest in their company, corporations can raise capital by selling stock.
- Recognized internationally: Corporations are recognized outside the U.S. while LLCs are not.
- Accounting benefit: S Corporations can choose to have the accrual method or modified cash basis accounting methods, while LLCs are not allowed to use the cash or modified cash basis accounting system.
Qualifying for S Corporation Status
In order to register your business as an S Corporation, it needs to meet certain requirements:
- The corporation needs to choose S Corp status within the first 75 days of forming.
- The corporation must be a "conventional," for-profit company that has only one class of stock. They cannot have issued both common and preferred stock already.
- The corporation's shareholders need to be U.S. Citizens or Permanent Residents.
- There cannot be more than 75 shareholders.
- The passive income of the company cannot exceed 25 percent of its gross revenue.
- If it is already an existing corporation, it cannot have lost sub-chapter S status in the last 5 years.
The IRS classifies businesses as either sole proprietorships, partnerships, C Corporations, or S Corporations. LLC are a legal entity, not a tax entity. Therefore, they are taxed as if they are a different type of business.
If you don't specify when you file, the IRS will automatically tax one-member LLCs as sole proprietorships and multi-member LLCs as partnerships. You can however, choose to be taxed as a C Corporation or as an S Corporation.
Some LLC companies can save money on self-employment taxes by choosing to be taxed as an S Corporation.
That being said, an S corporation often pays more tax than an LLC due to the extra payroll taxes and state corporate taxes that may be required. Any salary that an S Corporation pays to its owners is subject to state unemployment and disability tax. It is important to weigh up all the tax benefits and disadvantages before choosing your tax option.
S Corp Or LLC
Both LLCs and S Corporations will give you a certain amount of personal liability and overall legitimacy. If you are looking to upgrade from a sole proprietorship or partnership, either of these are good options.
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