You might be interested in the limited liability company (LLC), S corp (S-corp), or C corp (C-corp) business structures. An LLC is an ideal legal entity for small businesses that requires little maintenance. A S corporation is a tax status that allows business owners to save money on taxes. A C corporation, a more complex legal entity, is best for businesses that want to retain profits.
These business structures will be broken down and explained as clearly as we can. We will also provide information that small business owners need to know.
Before we go into a detailed explanation of LLC vs Scorp vs Ccorp, let’s first give you a quick overview of these three business structures and their functions:
What Exactly is an S-corp?
The explanation of S-corp is necessary because technically, the S-corp is not a business structure. It’s a tax status. The S corporation was created by Congress in 1958. It is also known as the small business corporation. This allows smaller businesses to enjoy the same tax benefits as corporations, but without double taxation.
S-corp is not a business structure, as is common online. It’s a tax status sometimes called a tax designation.
First, register your LLC or C-corp in the state where you are primarily doing business to receive the S-corp status. Once you have registered, send form 2553 the IRS to indicate that you would like to tax your business as an Scorp.
The problem is that many online legal services claim they can register your business as an Scorp. However, this is not the case. You choose an LLC, C-corp, and then designate (also known as “elect”) that business an Scorp for tax purposes.
Tip The S-corp designation is at the federal level (IRS), and not at the state level. If you are registering your company with the state (e.g. LLC or C-corporation), don’t be surprised to not see information about S corporations.
You may now be asking yourself why you would elect your LLC, C-corp or S-corp to tax status. The bottom line is to save money on taxes.
Why elect the S-corp tax status?
Let’s assume your LLC earns $75,000 net profit. This is after subtracting expenses. Congratulations! There is however bad news. The self-employment tax will be 15.3% and the cost is $11,475. Ouch.
If your business was an LLC, you would be responsible for paying $11,475 in taxes on $75,000 of net profit.
If your LLC was elected as an Scorp, it would be a different financial situation. You can lower the tax bill by taking out what is called a dividend. If you are not able to pay yourself a reasonable salary, a dividend is the money that is left. It is not easy to determine your business dividend, but bear with me.
This is a question you should ask yourself: How much would you be paid if you were paid for the work that you do in a similar business? Let’s take for example that an owner would pay $45,000 for you to do the same job in a similar business.
Some argue that a business owner cannot be compared to another managerial position. The IRS doesn’t care about this argument. Use your common sense to determine a salary.
Let’s go back to the example. Take your $45,000 “reasonable salary” and subtract it from the net income $75,000, leaving you with a $30,000. Dividend The best thing about an S-corp is that it doesn’t pay taxes on the dividend. This saves you $4,590. This is a huge amount of money to change your tax status to an Scorp.
Which business structure is right for you?
We’ll match you with the right product for your business by asking you some questions.
Why an LLC is better than an S-Corp
An LLC is a better choice than an S-corp if it helps businesses save money on taxes. If you make less than you would if you were in a similar job at another company, then you won’t be able to save money on taxes.
If you earn $40,000 in net profit and you feel $40,000 is a reasonable salary for the job you can just keep your LLC status without choosing S-corp tax status.
The downside to naming your business an S corporation rather than an LLC is the additional paperwork. You will also need to file more taxes. You’ll need to include Schedule K-1s on your business tax returns. A tax professional may be needed.
In addition, you’ll need to establish payroll with an Scorp.
Many business owners (including freelancers) choose to use an LLC for simplicity and to save time.
An LLC has many benefits
- Protection of personal assets
- It is easy to form
- There is less paperwork
- Unlimited members
Advantages of an LLC
- All net profits are subject to tax
- External capital raising challenge
- If a member leaves, the LLC will dissolve
LLC vs LLP
You may be interested in knowing the differences between a limited-liability company (LLC) and a limited-liability partnership (LLP). The LLP is usually used for professional businesses that have multiple partners who can be sued (aka doctors, lawyers and accountants).
You wouldn’t want your part of the business to be at stake if you were a doctor who opens a clinic along with two other doctors. An LLP allows each partner to take on different risks. The financial results of an error by one partner won’t be affected.
Why choose a C-corporation?
Why would someone choose to register their company as a Ccorp when they have the tax benefits of an S-corp?
A business may create a C-corp to save money on taxes. However, this is done through a different route. All profits are paid out with an LLC or Scorp. Profits can be retained within the business by using a C-corp.
For example, if your company earns $100,000 in net profits, you could get $75,000 and keep $25,000 (also known as “retained earnings”) within the business. Retained earnings are exempt from tax and held in a separate account.
The company’s net worth is increased when it has accumulated retained earnings. Apple, for example, retained approximately $80 billion in profits per year over the five years prior to COVID-19.
A legal requirement could also force a company to become a C-corporation. These are the situations when a corporation is required to become a C-corp.
- More than 100 shareholders
- Foreign shareholder
- As a shareholder in a partnership or another corporation
- Stock in multiple classes
- Some institutions (insurance and financial companies)
Benefits of a Ccorp
- Limitated liability
- Profits can be kept in business while you are not taxed
- The business entity will continue to exist even if the original owners have passed away
- Investor friendly
- Unlimited shareholders
Advantages of a Ccorp
- Double taxation at the individual and corporate level
- Annual board of directors meeting
- CPA assistance may make it more costly
How to Register as an Legal Entity or S-corp
DIY – You can register any legal entity through the state’s official website for business registration. A business registration fee can cost anywhere from $40 in Kentucky up to $500 in Massachusetts.
Online legal services: You can register your company using an online legal assistance if you have difficulty finding the state registration website. IncFile will collect and submit your business registration documents to your state free of charge, plus any state fees. They offer the most affordable service for business registration.
Online legal assistance: You don’t have to pay a fee for a local attorney to answer your legal questions. Instead, you can use a legal service like Rocket Lawyer. Rocket lawyer allows you to ask an attorney any question for $49.99 or unlimited questions for $39.99 per year.
A local business attorney is a good idea if you are forming a complex business such as an investor-ready Ccorporation. A good idea is to establish a rapport with local attorneys so that you can quickly resolve any legal issues.
Alternatives to the LLC, S-corp, or C-corp
This guide may help you to decide that C-corp and LLC are not suitable business structures. Perhaps you are a Massachusetts resident with a small business (that is unlikely to be sued) and don’t want the $500 fee for business registration. It’s a lot.
You also have the option of a sole proprietorship for one owner or a partnership for multiple owners. These business structures can be purchased for free. However, you might need to purchase a fictitious domain (also known as doing-business) through the state.
Although we don’t recommend sole proprietorships, I thought it was important to briefly explain it so you can understand why it’s legal.
You can’t register your company in any state where it is doing business. It will automatically become a sole proprietorship. If a business owner has a low-liability company (unlikely that they will be sued), it is preferable to remain a sole proprietorship to avoid paying the registration fee.
A sole proprietorship has one major drawback: if a customer ever sues the business, your personal assets could be at risk. What does this mean? If the judge finds your business to be at fault, he could order the liquidation or garnishment of personal assets in order to pay damages.
It is important to register an LLC or corporation. This allows you to keep the company’s liability for any damages that may be caused by a lawsuit.
A doing-business-as (DBA), also known as a fictitious business name, may be required if your business is a sole proprietorship. You will need to register your business as a DBA with state if you are operating under a business name other that your legal name.
A partnership is similar in structure to a sole proprietorship but it has multiple owners. If there are more than one owner, a partnership is the default business structure. As with the sole proprietorship model, all of the partners’ personal financial security is at risk if a vendor or customer sues the business.
We recommend a partnership agreement if you’re forming a partnership. This agreement will ensure that you and your partner both know what happens to the business in the event of a difficult situation, such as an inability or prolonged absence from work.
An LLC is the preferred choice for most owners who are starting a small business . A biz owner may elect to be an S-corp tax taxpayer if they believe it will help them save money on taxes.
A C-corp is a company that allows owners to retain a percentage of the profits from their business or raise capital from investors.