When starting up a business, it is practical if the owner knows the difference between an LLC vs S Corp vs C Corp. There are advantages and disadvantages of each business structure. There are features of each that are similar to each other, and other features that distinguish them.

What is an LLC?

An LLC, or “limited liability company,” shields the personal assets of the owners, or members, from any of the business’s creditors. It can be thought of as a combination between a partnership and a corporation. Essentially, it provides protection from personal liability against any of the LLC’s financial debts or legal liabilities. This type of business structure is regulated under state law, and every state, including Washington, D.C., allow businesses to form as an LLC. Under state law, an LLC is a separate, distinct legal entity from its owners, and the finances must be kept separate.

LLCs are an attractive option to business owners because they provide a lot of flexibility in forming and maintaining a business. It also provides flexibility for tax purposes. For instance, if an LLC is owned by a single person, it can choose to be taxed either as a sole proprietorship or a corporation. For a multiple-owner LLC, it can choose to be taxed like a partnership or a corporation. An LLC that elects to be treated like a sole proprietorship or partnership will pass through the taxes on its income to the owners’ personal tax returns. However, if taxed this way, the owners will be required to pay self-employment taxes on their entire income, whereas this is avoided if taxed like a corporation.

What is a C Corporation?

Similar to an LLC, a C corporation provides its owners, or shareholders, with personal liability protection. This means that the shareholders’ personal assets are unreachable by the corporation’s creditors. However, unlike an LLC, a corporation is very attractive to outside investors.

C corporations are not considered “pass-through” entities. This means that the corporation’s income is taxed at the corporate level. If there are any dividends distributed, then the shareholders pay taxes at the individual level. This is one of the major disadvantages of forming a C corporation; the corporation’s income is subject to double taxation, one time at the corporate level and one time at the personal level.

Other disadvantages of forming a C corporation include:

  • It is fairly expensive to form and maintain a C corporation
  • There are more formal paperwork requirements to abide by
  • There is less flexibility and more formal business requirements

Most states require that corporations hold annual meetings, take a formal vote on certain decisions, and submit annual reports.

Although it will vary from state to state, most states require a number of steps in order to form a corporation, including:

  • File Articles of Organization
  • Create an Operating Agreement
  • Create a Board of Directors
  • Appoint officers
  • Issue stock
  • Appoint a registered agent

What is an S Corporation?

The main difference between a C corporation and an S corporation is how they are taxed. An S corporation is considered a “pass-through” entity, similar to an LLC. This means that the S corporation itself is not subject to double taxation. The corporation’s income passes through to the individual owners, who then pay taxes on their personal tax returns. The corporation’s profits are not subject to self-employment taxes, but the shareholders must be paid a “reasonable salary.” Shareholders are technically considered employees of the S corporation, so any salary they receive will be subject to self-employment taxes, such as Medicare and social security.

An S corporation also cannot have more than 100 shareholders. The shareholders are required to be U.S. citizens or resident aliens. S corporations also provide their shareholders with personal liability protection, similar to an LLC and C corporation.

Business owners might think about forming an S corporation if:

  • They want the benefits of a corporation without being subject to double taxation
  • They want flexibility to set the “reasonable salary” of the corporation’s shareholders/owners
  • They want more flexibility with accounting methods

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