The limited liability company (LLC), S corporation (S-corp), and C corporation (C-corp) are three popular business structures that can be used for asset protection and income strategy.
LLC | S-corp | C-corp | |
|---|---|---|---|
What it is | Legal entity | Corporate tax status | Legal entity |
Best for | Simple businesses and solopreneurs | Businesses wanting to save payroll taxes | Startups or businesses seeking investors |
Liability protection | Yes | Yes | Yes |
Taxation | Pass-through taxation (can choose S-corp tax treatment) | Pass-through taxation (owners pay self-employment tax only on salary) | Double taxation (corporation and shareholders pay taxes) |
Self-employment tax savings | No (unless taxed as an S-corp) | Yes (distributions avoid payroll taxes) | No |
Ownership | Unlimited members | 100 or fewer US shareholders | Unlimited shareholders |
Raising capital | Limited — less attractive to large investors | Limited — investors generally must be individuals | Best option for large investors due to clear ownership structures, scalability, and divestment |
Administrative complexity | Low — minimal paperwork and compliance | Moderate —more recordkeeping than an LLC, but less formality than a C-corp | High — formal structure, high regulatory compliance, bylaws, and board meetings required |
Profit distribution | Flexible | Must be proportional to ownership | Dividends issued to shareholders, payroll compensation for employees (including employee-shareholders) |
Cost to maintain | Low | Moderate | High |
Think of choosing between these three business entities like roommate arrangements.
- An LLC would be akin to having an opportunity to share responsibility for the bills and home upkeep (shared liability).
- A single-member LLC (SMLLC) operates much like a sole proprietorship. It means that you can unilaterally decide on all the home decor and leave the lights on all day as long as you’re willing to pay the bill (decision-making autonomy).
- An S-corp is like having a roommate to split the bills with — plus getting a specific discount on the payments (shared expenses and tax savings).
- One common misconception is that an S-corp has a different base structure from a C-corp; however, an S-corp is simply a C-corp that makes an S election with the IRS.
- A C-corp would be similar to having a roommate to split bills with, but with an open contract that allows for more parties to split the bills, potentially with different levels of rights to the rental unit (e.g., use of the kitchen and the pool).
LLC vs S-corp
- LLC: Ideal for flexibility, simple operations, and small businesses not seeking outside investors
- S-corp: Best for businesses looking to save on self-employment taxes and willing to follow corporate formalities
While a business owner may save on payroll taxes by having an S-corp, the act of setting up and processing payroll might be more administration than they want to deal with. In addition, taxes become more complicated with an S-corp filing, and more documentation is necessary. An SMLLC offers simpler administration and maintenance.
In addition, for an SMLLC, you’d include your business activity directly on Schedule C of your personal tax return. If you elect S-corp status, you’ll need to report your business activity on a separate return filed on Form 1120S. For this form, you may need a tax professional’s assistance, which could further increase costs.
For simplicity’s sake, many business owners, such as freelancers, choose the LLC to avoid this additional work.
Both LLC members and S-corp shareholders pay income taxes on their net profits, but the amount of income that is subject to Social Security and Medicare tax (FICA taxes) differs. In addition to income tax, LLC members pay FICA tax on net profit (which is subject to self-employment tax), whereas S-corp shareholders only pay FICA taxes on their respective salaries.
LLC vs C-corp
- LLC: Best for small or midsize businesses wanting flexibility and simple taxation
- C-corp: Optimal for companies looking for significant growth, venture capital, or IPO potential
One of the main reasons you should start a C-corp is to save money on taxes — but through a different avenue. With an LLC or even an S-corp, the entire net income is taxed to the owner regardless of any cash payments made. Meanwhile, with a C-corp, profits not paid out as salary are taxed to the corporation at a flat income tax rate of 21%, which is much lower than the top individual rate of 37%.
As an example, if your business earns $100,000 in net profit, you could pay yourself a $75,000 salary. You would pay individual tax on the $75,000 salary, but the $25,000 profit after salary would be taxed to the corporation at only 21%.
There are also times when a business must be a C-corp because it is not legally allowed to be an S-corp. Under those circumstances, a C-corp would definitely be preferable to an LLC.
If you want the benefit of an unlimited number of owners but don’t want the administrative burden of the corporate structure, an LLC would be best. Operational administration in an LLC is also simplified when compared with a C-corp due to fewer formalities. In addition, pass-through taxation is an added advantage for LLCs since the structure avoids the double taxation issue associated with C-corps.
S-corp vs C-corp
- S-corp: Optimal for small or midsize businesses looking for tax benefits and simple structure
- C-corp: Ideal for larger businesses or those seeking venture capital, international investors, or IPOs
An S-corp is preferable for small or midsize businesses that won’t need an unlimited number of owners. S-corps have a shareholder cap of 100, which allows for enough ownership flexibility for the growth needs of most small businesses. As such, there’s no need for small business owners to endure the burdensome administration of a C-corp.
Larger businesses that might be interested in going public at a later date may want to be established as a C-corp. In addition to the unlimited number of corporate shareholders, incorporators can bestow varying levels of rights and ownership. These varying classes of ownership allow for the entity incorporators to put together very desirable ownership packages to attract new investors.
How does formation differ for each entity?
When you set up your business, you must follow the procedure established by each state for the initiation of a new entity.
How does dissolution differ for each entity?
If you dissolve your business, you must follow a structured legal process to wrap up operations and satisfy outstanding obligations — and the dissolution process may vary from state to state. While the three entities share similarities in dissolution procedures, they also have distinct differences due to their structural and tax characteristics.
Quiz: Which business structure is right for you?
Frequently asked questions (FAQs)
An LLC is neither by default, but elections can be made for the LLC to be treated as an S-corp or C-corp for tax purposes.
If you select a business structure and then later decide to change it, you’ll have to amend your formation documents with the state of registration. The new entity will be subject to the tax rules that apply to the new entity type.
One difference between an LLP vs LLC is that an LLP is generally managed by partners, while an LLC can be member-managed or manager-managed. In addition, an LLP is generally reserved for professional services, whereas an LLC can be used for most business types.
Bottom line
The best business structure depends on your business needs. An LLC is flexible and straightforward and offers pass-through taxation and liability protection. An S-corp maintains some corporate formalities but also enables business owners to save on self-employment taxes. A C-corp is superior for investment and growth opportunities; however, those benefits come with double taxation and administrative complexity. Selecting the proper structure hinges on tax strategy, ownership goals, and operational preferences.
