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Incorporate as an LLC, S-corp, or C-Corp ?

Posted In:  small business

Planning on starting a business soon? One of the first decisions you'll need to make is what type of entity your business is going to be. The most common choices are to form the company as an LLC, S-Corporation, C-Corporation, or as a Sole Proprietor.

Each one has advantages and disadvantages, and depending on the type of business you are starting, you could save yourself a significant amount of money by choosing the right one for your needs. Each entity varies, with some of them excelling at simplicity and flexibility, others with certain tax or legal benefits.  Other items of interest, like state filing costs, and protection of personal assets also vary across the different choices.

The chart below outlines some of the differences between an LLC, C-Corp, S-Corp, and a Sole Proprietorship:

 

 

  LLC C-Corp S-Corp Sole Propietorship
Personal assets protected from lawsuits?
protected protected protected personal assets at risk
 State filing costs
Must file with state and pay filing fees.  Must file with state and pay filing fees.

Must file with state and pay filing fees.

Not required
 Administration Overhead  low  Elections of board, corporate minutes, annual meetings, report filings.   Elections of board, corporate minutes, annual meetings, report filings.  low
 Founder Control of business activities  Any structure the owner wishes.  Shareholders elect directors to control business decisions.  Shareholders elect directors to control business decisions.  Owner has full control
 Company Terms of existence  Perputual in most states.  Perpetual  Perpetual  Company ceases to exist when owner quits business or dies.
 Taxation  Business not taxed, owner taxed as personal income pass-through.

 Taxed at corporate
rate. Double taxation if you pay dividends.

Business not taxed. Income passed
through to the
shareholders.
 Business not taxed, owners taxed as personal income pass-through.
 Typical Tax Forms  If 1 member, then Form 1040, Schedule C.  Multiple members, see IRS Form 1065 and K1  1120  1120S  1040
 Subject to Self-Employment Tax?  yes. Salary subject to self
employment tax. 
Salary subject to self
employment tax, but
shareholder
distributions are not
subject to
employment tax. 
 yes.
 Interest Transferrable?  Possible, depends on restrictions
in the operating agreement.
 Shares of stock are
easily transferred.
 Yes, but must observe
IRS restrictions on
who can own stock in an S-corp.
 no.
 Can offset taxes using medical reimbursement and other benefits?  no.  yes.  not for employee shareholders that own more than 2% of the company.  no.

 So, using the chart above, here's a few examples where choosing the right taxing entity for your company could save money:

  • Reimbursement of medical expenses.  This is a case where the C-Corp has a strong advantage, as it's the only entity than can leverage a wide range of IRS approved deductions and expenses, especially employee fringe benefits. A C-Corp can, for example, set up full reimbursement for medical expenses and deduct the full costs of that benefit, including paying the full cost of it's employee's health insurance premiums. The employees, including you as the owner/shareholder, will also avoid taxes on the value of that benefit.   The same holds true for other fringe benefits like retirement plans, transportation benefits, and qualified educational costs.
  • Avoiding "double taxation" -  If you plan to have corporate profits that will be distrubuted via dividends, be aware that a C-Corp will have to pay corporate tax on those profits.  Then, when the shareholders get their dividends, they'll have to declare them as income on their personal tax returns, and pay taxes again, at their own personal rates.  In this case, you may save money by forming as an S-Corp or an LLC.   Of course, another approach is just not to pay dividends.  The substantial freedom a C-Corp has to use fringe benefits ( see above ) to use up profits may allow you to avoid paying a dividend, thus avoiding the double taxation.
  • Simplicity - Depending on the amount of money coming into a company, and your ability to manage the complex paperwork yourself, a simpler entity could save you more money than a C-Corp or S-Corp does.   For example, if you find you need professional help to manage corporate minutes, tax returns, and the (rather complex) books for a Corporation, you could save money with an LLC.   The simpler nature, and pure pass-through of profits as income mean you could likely handle the administration yourself and avoid attorney, CPA, and tax-preparation fees.
  • Protection from personal liability.  While it may not save you money from the outset, the personal liability protections of either an LLC, S-Corp, or C-Corp, could save you everything.  A sole proprietorship, for example, has no inherent separation of the company from the owner/operator.  So, if your business is involved in a lawsuit, and you don't have the protection of an LLC or Corporation, your personal assets could be at risk.

Choosing the right entity, however, is a fairly complicated process, and not something that can be covered easily in a few web pages.  The decision as to what entity is best has a strong relationship to the legal tax implications.  Because of that, it would be an excellent idea to engage an attorney, as well as a Certified Public Accountant (CPA) to help you make the decision.

( editor's note: LCC is a common misspelling of the LLC acronym )

 

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