S Corp VS LLC VS C Corp – What’s The Difference?
It is crucial that new business owners understand the entity of the business they form as hundreds of thousands of entrepreneurs pay much more in taxes than they should because they have chosen the wrong entity for their business.
As a student learning all about how businesses work, I have compiled a summary of information that I have gathered from research online to explain the differences between business entities in less than five minutes. Enjoy.
LLC VS Corporations
Before forming your next business entity, here are a five things to consider based on the recommendations of attorney Elizabeth Weinstein.
- Look at your state and see if there are different filing fees to setup LLC or Corporation.
There are huge differences in price when forming a business entity in some places.
2. Determine if the owner is a U.S. citizen or has a green card.
An owner that has a green card or has U.S. citizenship can file for an S Corp, while an owner who is not a citizen cannot.
An owner who does not have citizenship, however, can have an LLC that is taxed as a partnership
3. If you are looking to pitch to venture capitalists, you will want to look at forming a corporation.
If you have a few friends that may want to invest in your startup, however, an LLC can be sufficient.
4. Determine the type of business you have.
Some businesses can only be a specific entity, such as business professionals who are not allowed to form LLC’s by the state they live in.
For more information, watch Weinstein’s video here:
Differences Between Entities
LLC’s are in place to help legally protect business owners.
Business owners with an LLC are not personally liable for obligations of their business, so if someone tries to sue, they cannot go after the owner’s personal assets.
If you form an LLC you can choose a default option to be taxed as either a sole proprietorship (if you are the only person in your business) or a partnership (if there are multiple people who own the business).
- Default option is fairly simple (especially if you are taxed as a sole proprietorship)
- Allows you to take any losses from your business and apply them directly to your personal income so that you pay less in personal income tax (this is known as a flow-through entity).
- If your business is profitable and you don’t distribute the profits to the owners at the end of the year, you still have to pay taxes on it.
- All profits are taxed in an LLC because the government assumes all money made has been distributed.
- Owners also have to pay self-employment tax.
To avoid self-employment on all LLC profits, business owners typically elect to be treated as an S Corp.
S Corps do not pay self-employment tax on distribution of profits to owners, but they MUST pay themselves a reasonable salary in which they will pay taxes on that.
This allows owners to decrease the amount they pay in taxes by minimizing the amount they pay themselves.
- If owners decide to take distributions of their profits, they will not have to pay self-employment income tax.
- Can be easier to get benefits such as loans from the government.
- Some banks tend to respect corporations more than LLC.
- Owners cannot only pay themselves through profit distribution to avoid taxes, they MUST take a salary.
- Limitations on who can claim businesses as S Corp based on owner requirements (citizenship for example).
- Limited amount of shareholders in the business.
- Higher scrutiny from IRS to file taxes accurately.
C Corps are the most common entity in the United States.
C Corps are better suited for businesses that intend to go public because there can be an unlimited amount of shareholders in the company, whereas S Corps have a limited amount of shareholders.
C Corps are much more attractive to potential investors as they do not have the same limitations as S Corps.
C Corps have income and expenses taxed to the corporation.
- C Corps can hold on to profits from the business so that the owners do not have to pay taxes on profits.
- You can have as many owners as you want as they are represented as shareholders.
- C Corps are the right choice for business owners who want a lot of investors in the business.
- C Corps can write off charitable contributions as an ordinary business expense.
- Falls under double-taxation, meaning the corporation pays taxes on profits and the owners pay taxes on the profits that are then distributed to them.
- More complicated than other entities.
- More expensive than LLC.
- Not a flow-through entity.
It’s crucial that you have a clear understanding of different business entities and that you have a great accountant to help find the best option for your business so that you don’t spend thousands of dollars more than you really need to.
At the end of the day, choosing between an LLC or corporation really comes down to your business goals, status of ownership, and the type of business you are operating.
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