How to Choose Between S Corp, C Corp and LLC

When starting a business, you may choose from three key options: C Corporations, S Corporations, and Limited Liability Companies. Each has different rules and tax effects. First, let's look at C Corporations:

C Corporation (C Corp)

Eligibility Requirements: To set up a C Corporation, you need to file papers with the state government. You must have directors and company rules and must give stock to shareholders. C Corporations are legally separate from their owners.

Liability: Shareholders cannot be held personally liable for company debts. This protects their personal property.

Management: Shareholders elect directors to manage the corporation. Directors appoint managers for day-to-day operations. The C Corporation has to hold annual meetings and maintain proper records.

Term: C Corporations can exist forever, even if original owners leave or die.

Taxation: C Corps are imposed double taxation:

1. The company is liable for a 21% federal tax on profit.
2. The dividends received by shareholders are taxed. This can be a burden on small enterprises, but it may allow large corporations to grow.

Self-Employment Tax: Employed shareholders pay regular payroll taxes but they do not pay self-employment tax. The company may deduct half of this tax.

Corporate Transparency Act (CTA): The CTA requires the C Corps to report to the government that owns them starting in January 2024 to deter illegal activity.

Tax Return: Every year, C Corps files Form 1120 with the IRS.

Initial Report: C Corps must tell the state they exist, usually within 90 days of starting. They may need to pay fees for this.

Annual Report: Most states require that the C Corps file an annual report. There is typically a fee for this as well. The report and its requirements vary from state to state.

Corporate Formalities: C Corps are greatly bound by:

• Write company rules.
• Keep minutes of meetings.
• Give out stock.
• Keep business money separate from personal money.

The failure to follow these may mean the owners lose some protection for their personal assets in legal problems. This is referred to as "piercing the corporate veil."

S Corporation (S Corp)

Eligibility Requirements: To qualify as an S Corp, a company must:

1. No more than 100 shareholders.
2. The only issue is one class of stock.
3. Restrict the shareholders to U.S. citizens or resident aliens only. S Corporations are formed like C Corporations, Including by filing Articles of Incorporation with the state and then issuing stock. They also must file Form 2553 with the IRS to elect S corporation status.

Liability: The shareholders of the S Corp have limited liability. A shareholder's personal assets are normally sheltered from the debts and legal liabilities of the business. However, they can lose this protection if they fail to observe formalities in maintaining a corporation.

Management: An S Corps is organized the same as a C Corps:

• Shareholders elect a Board of Directors.
• The Board supervises the company and appoints officers.
• Officers manage day-to-day operations. Annual shareholder meetings are mandatory, and detailed records of all corporate decisions must be kept.

Term: S Corps continue perpetually. The organization does not dissolve if ownership transfers or the original shareholders sell, quit, or die.

Taxation: One of the major advantages of S Corps is pass-through taxation:

• The company itself is not paying federal income tax.
• Profits and losses "pass through" to the shareholders.
• Shareholders report their share of income on personal tax returns. This structure avoids the double taxation faced by C Corps and thus, S Corps are generally attractive in the context of smaller businesses.

Self-Employment Tax: S Corp shareholders can reduce the amount of self-employment tax due:

• They reward themselves with a reasonable salary subject to payroll taxes.
• Additional profits can be distributed to owners in the form of dividends, which are not subject to self-employment taxes. The IRS, however, scrutinizes S Corps for reasonable salaries on the work performed.

Corporate Transparency Act: Starting in January 2024, the S Corps will have to report their beneficial ownership to FinCEN. This includes owners or any person in control of the company. Penalties for non-filing are severe.

Tax Return: S Corps is required to file Form 1120-S annually with the Internal Revenue Service. This form displays the company's income, deductions, and credits. Shareholders are given a Schedule K-1, which shows their share of the company's income, to report in their personal returns.

Initial Report: Most states require S Corps to file an initial report shortly after formation, typically no later than 90 days. This generally includes basic information about the company and may involve a filing fee.

Annual Report: S Corps usually must file annual reports with their state of incorporation. These reports update the state on basic company information and often require a filing fee. Requirements and deadlines vary by state.

Corporate Formalities: S Corps must strictly follow corporate formalities, such as:

• Creation and maintaining bylaws
• Regular holding of board and shareholder meetings
• Keeping detailed minutes of the meetings.
• separation of business and personal finances
• Issuance of stock certificates to shareholders

Limited Liability Company (LLC)

Eligibility Requirements: LLCs offer more flexibility than corporations:

• Governed by an Operating Agreement instead of bylaws
• No requirement for a Board of Directors
• Can be managed by members or appointed managers
• As of 2024, must comply with the Corporate Transparency Act by reporting beneficial ownership to FinCEN

Liability: LLC members have limited liability protection:

• Personal assets are generally shielded from company debts
• Exception: If members personally guarantee a loan, they can be held liable
• Maintaining proper separation between personal and business finances is crucial

Management: LLCs have two management options:

1. Member-managed: Owners directly manage the company
2. Manager-managed: Non-members are hired to run the business This flexibility allows LLCs to adapt to various business needs and owner preferences.

Term: LLCs typically have perpetual existence, continuing indefinitely unless the Operating Agreement specifies otherwise. This allows for business continuity regardless of changes in ownership.

Taxation: LLCs benefit from pass-through taxation:

• Profits pass through to members' personal tax returns
• Single-member LLCs file taxes using Schedule C (part of Form 1040)
• Multi-member LLCs file Form 1065 (Partnership Return) Members can also elect to have the LLC taxed as a corporation if beneficial.

Self-Employment Tax: LLC members are typically subject to self-employment tax on their earnings:

• Includes both employer and employee portions of Social Security and Medicare taxes
• Can be a higher tax burden compared to corporation structures

Corporate Transparency Act (CTA): Starting in 2024, LLCs must report beneficial ownership information to FinCEN:

• Aims to prevent financial crimes through anonymous corporate structures
• Failure to comply can result in significant penalties

Tax Return:

• Single-member LLCs: Report profits on individual tax returns (Schedule C)
• Multi-member LLCs: File Form 1065 and provide Schedule K-1 to each member

Initial Report: Most states require LLCs to file an initial report with the Secretary of State:

• Usually due within 90 days of formation
• This may involve paying state fees
• Provides basic information about the LLC to state authorities

Annual Report:

• Most states require annual or biennial reports
• Often accompanied by a filing fee
• Frequency and requirements vary by state
• Keeps state records up-to-date with current LLC information

Corporate Formalities: LLCs have fewer formal requirements than corporations:

• Not required to hold annual meetings or keep meeting minutes
• An Operating Agreement is strongly recommended (and required in some states)
• Should maintain separate business bank accounts and records
• Regular member meetings and record-keeping are advisable for legal protection

While LLCs offer more flexibility and fewer formalities than corporations, maintaining good business practices and clear records is crucial for preserving limited liability protection and ensuring smooth operations.

New 2024 Federal and State Reporting Requirements

The Corporate Transparency Act takes effect in January 2024, and among the requirements, FinCEN will mandate reporting of beneficial ownership for all businesses, whether C Corps, S Corps or LLCs. It would apply to most U.S.-based entities to drive corporate transparency. Compliance deadlines are as follows:

Existing businesses: January 1, 2025

New entities: Within 90 days of formation

Cost of Starting a Business

Incorporation and LLC formation filing fees in the United States are generally between $250 and $350, depending on the state. Note that additional fees apply for trademarks, among other services, available in various states.

Business Loans and Credit Requirements

For business loans, lenders often require a credit score of 680 or higher. If your score is lower, consider improving it by paying down personal debt before applying for a loan.

Frequently Asked Questions (FAQ)

Information Source:

(ICLG Business Reports)

(The Cavanagh Law Firm, P.A.)

(Brooks Pierce)

(Mondaq)

(GreenGrowth CPAs)