When trying to decide between LLC, C Corp, or S Corp for your business, it’s important to understand the differences between them and the tax advantages for each. This will help you choose the best entity for it.
An LLC is considered a disregarded entity when it comes to taxes. Profits and losses are placed on the owner’s personal tax return, despite the business entity being regarded as separate from the individual. This is how it provides liability protection in case of a lawsuit. In other words, the owner’s personal assets are not at risk if the LLC business is sued. This is the most common reason people decide to get an LLC for their business.
The business can distribute profits and losses among the owners. Monetary, time, and effort invested in the business can be included in the distribution.
LLC business can take advantage of S Corporation tax benefits, which will be covered below.
When a business is a C Corporation, it is a completely separate entity - legally and for taxes. All profits, losses, and liabilities stay with the business - not the owners. Of course, with the business being completely separate, owners are completely free from liability if anything legal were to happen.
Profits are taxed at the corporate income tax rate, which could benefit the owner greatly depending on where the incorporation took place.
C Corporations often have more tax deduction opportunities than other entities such as LLC, partnership or sole proprietorship.
C Corporations can also be taxed as an S Corporation. This can save the business from being taxed twice. The potential of being taxed twice as a C Corporation is one of the reasons many people decide against it. Since C Corporation profits are taxed when they are earned and then taxed again when paid as a dividend to shareholders on their individual tax returns.
An S Corporation is not a legal entity. It simply qualifies an LLC or corporation.
Self-employment tax is high, and an S Corporation lessens the burden for LLC business owners. With the S Corporation, only income paid to LLC owners on a payroll gets taxed as self-employment. Distributions are not taxed by Social Security and Medicare. This is why many people decide to form an LLC - to reduce their personal tax burdens.
C Corporations qualified as S Corporations are not double taxed. Profits and losses go straight to the shareholder’s personal tax returns. This misses the first round of taxation. In other words, the C Corporation doesn’t pay income tax. It’s the shareholders that end up paying self-employment tax.
There are some caveats with S Corporations:
1. Those under the S Corporation cannot have more than 100 shareholders.
2. LLCs must compensate their works fairly or the IRS will take note and think owners are trying to avoid self-employment tax when the majority of profits are distributions.
Now you have a better idea of which entity you should choose for your business when considering tax advantages. LLC and C Corporations with possible S Corporation qualifications are your choices. Small businesses may want to stick with an LLC, while larger ones a C Corporation may be a better match.