If you are looking to start a new business, it is important to understand the two most common legal entities that can be formed for doing business in the United States - C corps and LLCs.
The C corp and LLC are both business structures that help a company to lower its tax liability.
However, they differ in the way that they operate. C corps are taxed differently than LLCs - C corps pay taxes on their net earnings while LLCs do not.
An LLC has greater flexibility in ownership structure, but C corps has more protective provisions for investors if there is any mismanagement of funds.
The choice between these two structures often depends on what type of business you want to run or your goals as an entrepreneur.
What is a C Corporation?
A C corporation represents a business entity formed by filing all the required paperwork with your state.
The business can be owned by corporation shareholders, which are people who have bought shares in the business.
A shareholder's liability for business debts and other financial obligations ends when they sell their stock or lose their position as a company officer.
This business entity is taxed on business profits, which are then distributed to shareholders as dividends.
These earnings are subject to double taxation because the corporation itself must pay taxes before distributing dividends.
Corporations work by creating a management structure that includes officers and directors, who are usually business employees.
If the corporate structure fails, shareholders are protected from liabilities because they do not have management positions in the corporation.
This business type is appropriate for companies with many investors seeking high control over company activities and management.
The Benefits of C Corp
The benefits of C corporations include:
- Company profits are taxed only once at the corporate level; and,
- Company shareholders cannot be held personally liable for company debts.
However, corporations pay taxes on their net income after expenses and dividends are received from other companies.
Corporation owners must also abide by laws that apply to all U.S. businesses, including federal tax codes and employment guidelines like social security rules.
The corporation is considered a separate legal entity, so employees can form contracts with clients or sign leases without involving the company board of directors or officers in the agreement process.
This business type is appropriate if your company needs these benefits:
C Corp pays its own taxes distributing dividends to you, making it a good company to use when you need your company's profits for personal or business needs.
C Corp is best if you are trying to raise money from investors because they see it as a more professional business structure than an LLC.
What Is a Limited Liability Company?
Limited liability companies, or LLCs, are pass-through entities that provide limited liability protection.
This means that members of an LLC aren't personally liable for the company's debts and obligations.
So if you were sued because your business failed to pay back a loan from a bank, creditors couldn't come after your personal assets such as a house or car.
LLC members are individuals or corporations that own an interest in the business and share profits. Their assets are protected, just like with a corporation.
However, pass-through taxation for LLCs is less complicated than the corporate tax structure because it's reported on owners' personal income taxes—just as if they had earned that money personally.
LLC owners are not taxed for profits made by the LLC.
Pass-through taxation means you don't need to pay additional taxes on your business income; instead, it's reported alongside your personal tax return and incorporated into what you owe (or receive as a refund) at year-end.
Any unincorporated business, such as sole proprietorship and partnership owned by one or more individuals who report their share of the taxable profit or loss in their individual tax returns, passes their financial burden onto owners just like shareholders do with C corporations.
The Benefits of LLC
The benefits of LLCs are numerous. First, LLCs can be much more flexible regarding personal liability for business debts and liabilities, including taxes.
Second, the owners or members of a multi-member LLC are not personally liable to creditors who have an unsatisfied claim against these businesses if they were unsuccessful in filing personal bankruptcy against their own assets as well.
Because each member has only entered into a limited personal liability with their co-owners by contract during formation, you aren't responsible for what your partner does after that point (until you agree to take on additional personal responsibility such as signing contracts).
Since its inception, this type of legal structure has often been used by small business owners and real estate investors looking to protect themselves from their rental properties and personal property lawsuits.
Paying Taxes: LLC vs. C Corp
An LLC is taxed differently from a corporation. Instead of filing taxes at both state and federal levels as corporations do, it files only one tax return each year at its own specific income bracket based on how much money was made during the said period taxable year.
LLCs don't pay taxes on their earnings; instead, they pass income or losses through to individual members who report them on their personal tax returns.
An LLC is a disregarded entity, which means that it has no separate corporate existence from its members.
An LLC may elect to be taxed as a corporation, meaning the income is taxed twice at the corporate level and again when shareholders receive dividends (or upon sale of their stock).
C corporations are responsible for filing their own tax returns with state and federal agencies; they also file an informational return under subchapter S if they meet certain criteria.
While some states have corporate taxes on sales or incomes, most do not require them unless they have offices within those respective jurisdictions.
C corporations must pay corporate income tax before passing earnings through to individuals who then report taxable amounts on personal returns.
Each member's proportionate share of profit distributions determines whether any resulting tax liability falls on the corporate entity or its members.
Members of an LLC pay taxes through their individual returns concerning allocations from their company's profit and losses - not just for wages they receive as compensation for services performed.
Because double taxation is generally avoided through this process, partnership taxation rules can be applied by default unless otherwise modified by an operating agreement between partners (except in cases where corporate characteristics exist).
This type of business structure provides pass-through liability protection that shields member assets from possible debtors who might try to target any assets.
The members of pass-through LLCs do not pay self-employment taxes. Instead, they make estimated tax payments and file an informational return each year to report income and expenses.
C corporations don't pay self-employment taxes. As a C corporation, you will be taxed on the business's profits and any salary you pay yourself.
You do not pay self-employment tax as an employee, but the company pays the employer's share of those taxes.
What Is the Difference Between C Corp and S Corp?
The difference between a C corporation and an S corporation is in how the business is taxed. For both, federal taxes are separate from personal income taxes for shareholders and employees of the company.
The key difference has to do with which type of taxation applies when there is a transfer of shares or distributions made by the corporation to its shareholder(s).
The C Corp:
When it comes time for your business to distribute profits (dividends) after you've met all expenses, paid yourself salary/wages, covered other corporate costs like insurance premiums, etc., you will be required to pay corporate tax on any money remaining before paying dividends.
After deductions and exemptions, this could mean double taxation - once at the corporate level and again at an individual level.
The S Corp:
An S corporation pays taxes at the shareholder level. When your business pays you a salary for services performed, it is taxed at normal rates - the same as an individual in this case since S corporations are pass-through entities (unlike C corporations).
Many small business owners choose to form their LLCs as S corporations because of the tax benefits.
Still, there are also distinct differences in how state laws treat each with regard to taxes, liabilities, management structure, and personal asset protection from creditors.
An LLC taxed as an S corporation will have more tax benefits and possibly taxable income deductions.
In contrast, an LLC taxed as a C corporation will have greater legal and financial protections (lower tax rates, less corporate paperwork, more equity financing options, no ownership restrictions, etc.).
Do C Corporations Pay More Taxes Than LLC?
A C corporation is taxed separately from its shareholders. They pay both federal income tax and then pay personal income tax on shareholders' personal returns.
An LLC is a pass-through entity which means it's taxed similar to sole proprietorships, and so a business owner only pays his/her own income taxes. Their personal income tax rate will differ from their LLC taxes.
Does an LLC Pay Corporate Tax?
No. LLCs don't pay corporate taxes unless they choose to be taxed as a C or S corporation.
Do Corps Need Separate Bank Accounts?
Yes. Regardless of whether you chose a C or S corp, you will need a separate bank account to shield personal assets from the corporation's assets.
Can a Single-Member LLC Be a C Corp?
Yes. Single-member and multi-member LLCs can be C corporations if they opt for corporate taxation.
C Corp vs. LLC: The Final Verdict
The most important factor in deciding whether to start an LLC or a corporation depends on your business goals and plans.
If you want pass-through taxation without added paperwork, consider forming an LLC instead of a regular partnership or sole proprietorship.
In addition, limited liability protection makes an LLC particularly attractive when other members don't actively participate in day-to-day management decisions but share profits from the company's success.
Suppose your business does not meet the requirements for an LLC.
In that case, a corporation is usually the best option to protect assets from company liabilities and access more funding possibilities than with other legal structures.