How to Choose Between a LLC or a C or S Corporation

 

Choosing the correct business structure can be a very complicated and confusing challenge confronting small business owners. There are three main categories of business structure to begin with: sole proprietorship, partnership, and corporation. The structure of corporations can be broken down to either a C or S type of incorporation. Small business owners are given an additional choice of forming a limited liability company, or LLC, that does not quite meet the incorporation criteria, but shares many of the same benefits as a corporate structure.

The simplest form of business structure is the sole proprietorship, which can be easily started by just about anyone who wants to start a business. The most involved is, of course, the C or S Corporation which carries the requirement of filing and paying fees to the state where the business operates. Many small business owners are hesitant to incorporate because of the need to file with the state. In order to decide which business structure is the best for your business, you should look closely at your business goals and long range growth plans in order to better compare your business structure options.

The following table contains an overview of the basic business structures to make a comparison of their major differences.

	Type of Filing	Liability	Longevity	Tax
Sole proprietorship	None	Owner is personally liable	Not perpetual	Paid by business owner
C corporation	Articles of incorporation	Corporation itself, not its shareholders, are liable	Perpetual	Possible double taxation by both corporation and individual shareholders
S corporation	Articles of incorporation	Corporation itself, not its shareholders, are liable	Perpetual	"Pass through" taxation paid by shareholders, not corporation
LLC	Articles of organization	Limited personal liability of owner	Perpetual	"Pass through" taxation

 

It is time to look a little closer at some of these characteristics.

Limited Liability Companies (LLC)

From the table above, you can see that both an LLC and corporations begin with filing appropriate paperwork. All it takes to create and LLC is to choose a business name and file your articles of organization in the state that the business is to operate. The regulations that govern corporations and business structure will vary from state to state, so it is important that you research the specific requirements for the state in which you will operate your business.
There are some benefits to filing as an LLC, such as:

• The owners of the LLC only have a limited liability for debt or other legal obligations, which will usually remain with the business entity and not the owners of the entity
• The owners of the LLC pay any due income tax and not the LLC, so you don’t get hit with the double taxation that happens in a C corporation.
• The LLC is a separate entity from the owner, and so can continue even in the event of the owner’s death.
• The business organization for LLCs is basic and uncomplicated with no requirement for directors or a board or even annual meetings as with corporations.

Small business owners are realizing the advantages of a straightforward and simple to manage business structure, increasing the popularity of the LLC to the point that new LLC’s outnumber new corporations by a factor of tow to one.
Corporations

The more complicated corporate business structure requires that you file the articles of incorporation with the state (or states) that you plan for business operations. This will set the corporation name, the board of directors, and establishes policies over the shareholders.

In spite of the complicated structure and filing requirements, corporations do have the following benefits:

• The corporation is a legal entity and is liable for debt and other legal responsibilities and not the individual shareholders. A corporation can be sued and taken to court, but individual shareholders cannot. This is a very appealing layer of protection that becomes even more attractive in a recession economy
• A corporation does not dissolve at the whim or even death of any one shareholder, but will continue indefinitely until such time as the board votes to terminate or dissolve the corporation. It is not tied to the founder or any individual, which is how it happens that sometimes the person who started the company can get voted out of the company by the board of directors.
• The corporate business structure is usually more attractive to investors than a sole proprietorship.
  Corporations do have some distinct advantages, and they are also the most complex of all the business structures, but can’t hold a candle to the complexity of the IRS tax codes. The differences between a C and S corporation are made by the way the tax obligations of each type of business structure.

C Corporation and Taxation

The C Corporation’s tax liability is defined by the IRS tax code in Chapter 1, Subchapter C and establishes it as a separate business entity from the company owners, which is another way of saying shareholders. The IRS tax codes then goes on to say those corporation shareholders are entitled to be taxed on any dividends they get from the corporation, which is your basic definition of the double tax. Consideration of the double tax liability is an important consideration for the small business owner when considering how to structure their business.

It does seem as though the C Corporation would not be a very good choice for businesses just because of the double taxation issue, but there are some actual tax advantages that go along with this type of structure. An example of a tax advantage would be the reduced rate of IRS audits, even with losses reported several years running, while sole proprietorships and partnerships are much more likely to be audited. There are some deduction advantages as well, such as some employee benefits like health insurances costs are made 100% as deductions, which is a big advantage for a small business.
S Corporation and Taxation

The S and C Corporation are both designations by the IRS, with the S corporation defined in Chapter 1, Subchapter S. The main difference from the C Corporation is that the double taxation has been removed by passing all tax liability through to the individual shareholders. The incorporation advice most given new business owners is start with an S Corporation, but you should always get the advice of a tax specialist in order to consider all the options as they relate to your business.
Each individual state defines the requirements to form and operate a corporation business structure, but it is the IRS which defines a C and S type corporations and are only specified for tax liability only.
It is important to know that you can change the structure and type of business as your business grows and changes. However, it is always best to build in structural growth considerations right from the start, as in the business planning stages, even before starting the business.

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