Selecting the appropriate legal structure is a key decision for any entrepreneur starting a new business. The business entity you form impacts everything from day-to-day operations, taxes, liability protection and more. This guide will demystify the pros, cons and differences between the three most common options – LLCs, S Corps and C Corps.
With detailed comparisons and an overview of how each structure works, you’ll be equipped with the knowledge to determine which is best for your company.
Table of Contents
What is an LLC?
LLC stands for Limited Liability Company. It is a business structure that combines traits of partnerships, sole proprietorships and corporations.
- Members have limited personal liability for business debts and obligations
- Tax flexibility – can choose to be taxed as Sole Proprietorship, Partnership, S Corp or C Corp
- Less administrative paperwork and compliance requirements
- Easy to form and maintain
- No limit on number of owners and greater flexibility in member management structure
- Members’ personal assets may still be at risk and need additional protection
- Self-employment taxes apply to member income
- Less credibility with customers than a Corporation
- Limited lifespan – some states require dissolution after 30 years
LLCs are the simplest business structure and popular for small businesses and startups. They provide liability protection with fewer formalities than corporations.
What is an S Corporation?
S Corporation or S Subchapter Corporation is a separate legal entity that passes income, losses, deductions and credits through to shareholders’ personal tax returns.
S Corp Pros
- Limited liability for shareholders
- Pass-through taxation – no corporate taxes
- Shareholders only pay taxes on dividends
- Separate tax entity from members
- Ownership is transferrable through stock sales
- Unlimited lifespan
S Corp Cons
- Complex and expensive to set up and maintain
- Extensive record keeping and compliance requirements
- Must follow corporate formalities like adopting bylaws
- Strict rules on number and type of shareholders
- Double taxation risk if formalities not followed
S Corps avoid double taxation but have more IRS rules than LLCs. They offer liability protection and credibility of a corporation with pass-through tax benefits.
What is a C Corporation?
C Corporations are separate legal entities owned by shareholders. They are taxed separately from owners and are more complex than LLCs and S Corps.
C Corp Pros
- Limited liability for shareholders
- Separate entity from owners
- Stock sales allow ownership transfer
- No limit on shareholders or ownership types
- Perpetual existence
- Easier to attract investors and sell shares publicly
C Corp Cons
- Double taxation – entity taxed then shareholders on dividends
- Complex formation and reporting requirements
- Closely held owners pay higher taxes
- Greater exposure to lawsuits
- Require regular board meetings and minutes
- Difficult to dissolve once established
C Corps offer the most flexibility but are more complicated. They work for larger, established companies and those seeking Venture Capital.
Now that you understand the basics of LLCs, S Corps and C Corps, let’s compare them across key factors that impact your business.
LLC vs S Corp vs C Corp Comparison
Ownership Structure & Control
- Owned by “members”
- Unlimited members allowed
- Any type of member ok
- Flexible management structure
- Owned by “shareholders”
- 100 or fewer shareholders
- Only individuals, estates and certain trusts
- More rigid structure
- Owned by “shareholders”
- Unlimited number of shareholders
- Stock can be publically traded
- Formal and complex structure
For simple co-owned companies, LLCs provide the most flexibility. S Corps and C Corps are better for bringing on investors.
- Members protected from debts and liabilities
- Personal assets usually not at risk
- Shareholders have limited liability
- Business debts stay within corporation
- Shareholders are not personally liable
- Maximum liability protection for owners
All three structures provide liability protection for owners. C Corps offer the highest level.
- Pass-through taxation
- Members pay personal income tax on share of LLC income
- Tax flexibility – can choose how LLC is taxed
- Pass-through taxation
- Shareholders pay income tax on their share
- No corporate level taxes
- Entity taxed on profits
- Double taxation – shareholders also taxed on dividends
- Higher taxes, especially for small C Corps
For pass-through taxation, LLCs and S Corps have tax advantages over C Corps. LLCs offer the most tax flexibility.
- Simple formation process
- Minimal paperwork and compliance
- Few ongoing formalities
- More extensive formation process
- Stricter record keeping and meetings
- Must follow corporate bylaws
- Most complex formation
- Extensive reporting requirements
- Strict corporate governance
LLCs involve the least red tape allowing owners to focus on running the business. C Corps are heavily regulated entities.
- Difficult to attract investors
- No stock issuance
- Need complex operating agreement
- Can issue shares to bring investors
- But limits on shareholders
- Best for attracting investment
- Unlimited shareholders
- Public stock issuance potential
C Corps have advantages issuing stock for capital raises from angel investors or VCs.
Credibility & Marketing
- Less familiarity among public
- Signals small, new company
- Corporation status conveys permanence
- Most widely recognized structure
- Communicates scale and success
Corporation names can improve perception among customers and partners compared to LLCs.
As this comparison shows, each structure has pros and cons across these key elements. The best choice depends on your specific priorities and situation as a business.
Now let’s walk through a decision process on choosing between an LLC, S Corp or C Corp.
How to Choose Between LLC, S Corp or C Corp
Follow this step-by-step methodology to determine the ideal corporate structure for your small business:
Step 1 – Consider Your Goals
Start by thinking about what you want to accomplish with your entity choice – liability protection, tax savings, and flexibility for future growth or exits.
Prioritize your main goals so you can objectively compare structures.
Step 2 – Evaluate Ownership Plans
Do you plan on co-owners or bringing on investors? That impacts options like stocks. Will future transfers be between family or strategic sales? Factor in ownership plans.
Step 3 – Assess Tax Implications
Model out the tax liabilities under each structure based on your projected revenue and costs. Compare pass-through taxation vs. double taxation on dividends.
Also factor in impacts to your personal income taxes. Consult an accountant to run scenarios.
Step 4 – Gauge Operational Needs
How much time do you want to spend on legal administrative tasks vs. growing your business? Complex structures have more compliance requirements.
Also consider any industry-specific needs or barriers to entry. For example, specific licenses may require S Corp or C Corp status.
Step 5 – Consider Future Plans
Think ahead to how you may evolve the business over 2-5+ years. Will you need to issue shares, acquire companies or go public? Ensure your structure scales.
Also factor in future financing needs and ease of transferring ownership when you eventually exit.
Step 6 – Consult with Experts
Talk to attorneys and accountants to get input on the ideal structure for your situation before deciding. They can point out pros and cons you may overlook.
With the right entity choice, you maximize advantages and minimize hassles from a tax and operational perspective. Rushing into the decision without planning can create major headaches later.
While the process may seem complicated, taking the time upfront to fully evaluate and choose the right structure sets your business up for success.
LLC vs S Corp vs C Corp: How Do I Decide?
As a quick recap, apply this decision framework when choosing between LLC, S Corp and C Corp:
- Simplicity is top priority – Form an LLC to minimize formalities
- Seeking investors or IPO – C Corp provides most flexibility
- Co-owned with family or partners – LLC limits restrictions on members
- Raising capital from Angels or VCs – S Corp or C Corp for share issuance
- Revenue over $1 million – C Corp double taxation starts to diminish benefits
- Maximize tax savings as owner – LLC pass-through or S Corp benefits
- Prefer pass-through taxes – LLC or S Corp avoids high C Corp rates
- Mixing business with personal assets – LLC or Corp protects personal assets
- Industry requires specific entity – Comply with regulations for your field
This boils down key factors to evaluate when making your LLC vs S Corp vs C Corp decision.
Switching Entity Type Later On
What if you initially form as one type of entity, but later realize a different structure would be better for your evolved business?
Thankfully, it is possible to switch between LLC, S Corp and C Corp later on. Here are the primary paths:
- Start as LLC, then elect S Corp status down the road
- Start as LLC, then incorporate as a C Corp in the future
- Start as S Corp, then switch to a C Corp
- Start as C Corp, then convert to an S Corp (more complicated)
So don’t feel like your initial choice in entity locks you in forever. Just be aware conversions can be complex and have tax implications in some cases. Consult a business attorney and accountant before making any changes.
LLC vs S Corp vs C Corp: Frequently Asked Questions
Below are answers to some common questions small business owners have when choosing between LLC, S Corp and C Corp structures:
What is the simplest entity to start?
LLCs have the fewest formation requirements and ongoing compliance rules. LLCs allow business owners to get up and running quickly and easily.
Which provides the most liability protection?
C Corporations offer shareholders the highest degree of limited liability. LLCs and S Corps also protect owners from personal responsibility for business debts and claims.
How do taxes compare between LLC and S Corp?
LLCs provide greater flexibility in how they are taxed – as a sole proprietor, partnership, S Corp or C Corp. S Corps offer automatic pass-through taxation without filing a corporate return.
Is an LLC or S Corp better for a small business?
Most small businesses choose LLCs or S Corps. LLCs are simpler while S Corps provide corporate-style credibility. Evaluate trade-offs based on your goals.
Can I change business structure later on?
Yes, you can convert from an LLC to S Corp or C Corp down the road if your needs change. Be aware legal and tax implications vary by conversion type.
What if my business exceeds S Corp shareholder limits?
If your S Corp exceeds 100 shareholders, you will need to convert to a C Corp. Consult your tax advisor beforehand to understand implications.
How do I choose between pass-through vs. C Corp taxation?
Project your future income and expenses, then model potential tax liability under each approach. Weigh savings vs. administrative costs.
Should I consult a lawyer or CPA to decide?
Yes, consulting qualified legal and tax advisors is highly recommended before settling on an entity. They can validate your assumptions and selection.
LLC vs S Corp vs C Corp Comparison Chart
|Number of Owners Allowed
|Up to 100 shareholders
|Only individuals, estates, some trusts
|Rigid corporate structure
|Hierarchical corporate structure
|Pass-through or corporate
|Double corporate taxation
|Difficult, no stock
|Can issue stock
|Best for issuing stock
|Right for Small Business?
|Can convert to S or C later
|Can convert to C later
|Difficult to convert to LLC or S
This summarizes the key comparisons in a convenient table. The best choice depends on your goals, tax situation and future plans.
Next Steps to Choosing a Business Structure
Deciding between LLC, S Corp and C Corp does not need to be intimidating or confusing. Follow this process to make an informed decision:
- Document your priorities and business goals
- Carefully assess ownership, liability, taxes, and future plans
- Understand key trade-offs between each structure
- Model tax scenarios and operational impacts
- Consult legal and accounting advisors
- Make choice aligned to your goals and situation
With education and planning, you can select the ideal business entity to maximize advantages and avoid hassles. Just don’t put off the decision – forming the proper structure early makes operating smoother as you scale.
Many small businesses never outgrow an LLC. But even if you start as an LLC, know that you can convert to an S Corp or C Corp later on if the benefits begin to outweigh the extra complexity.
Whichever route you take – LLC, S Corp or C Corp – following this guide will equip you to make the best decision with confidence.