Business Structures for Self-Employed
Choosing the right legal structure for your business is a crucial step that can have far-reaching implications for its growth, taxation, and legal obligations. Among the various options available, three popular choices stand out: Limited Liability Company (LLC), S-Corporation (S-Corp), and C-Corporation (C-Corp). Each structure offers distinct advantages and disadvantages, catering to different business needs and goals.
In this blog, we will delve into the key characteristics, benefits, and considerations of LLCs, S-Corps, and C-Corps. By understanding the fundamental differences between these business entities, you can make an informed decision that aligns with your entrepreneurial vision.
LLC vs S Corp vs C Corp
What is a Limited Liability Company?
An LLC (limited liability company) is basically what it sounds like; it’s a company set up by an individual or group to limit their personal liabilities in the business so they can operate it as a separate entity from their personal finances.
Advantages of an LLC
The advantage of this type of filing entity exists mostly on the legal side: it creates an EIN (employer identification number) with the federal government that signifies your company can be treated as a separate entity from your personal tax filings. This insulates (in a limited way) your personal finances from being affected by anything going on in your business while also still leaving in place the ability to draw money when you need it from the company. This isn’t considered compensation that is taxable; equity draws are almost always taxed before you take them and, as such, are not taxable.
However, the limits of the LLC structure are that in a tax-paying sense it really doesn’t create much in the way of benefits. An LLC is a “pass-through” entity, meaning the income from the business passes through the LLC and lands on your personal return in the form of a Schedule C (or via a Schedule K if you’re in a partnership LLC). There’s almost no difference in this regard for you the taxpayer than if you never made an LLC, to begin with. The LLC won’t really do much to blunt the tax impacts for you from the business.
What is a C Corporation?
Also known simply as corporations, this is a company type that comes with a lot of personal liability protection for the owners but a lot more restrictive handling of the company. Corporations are considered tax-filing entities with their own income tax liabilities separate from the people who actually exist in the company.
Legally, you need to have specific documentation on hand to prove the legitimacy of the company and the amount owned by various individuals; you are unable to just pull money from the company without running it through payroll or issuing a dividend to all holders of stock, a process which is formalized by a board vote at regular intervals.
C corporations are subject to double taxation. The corporation itself is taxed on its profits at the corporate tax rate, and then any distributions made to shareholders in the form of salaries, bonuses, or dividends are taxed again at the individual level.
There are cases where self-employed would benefit from a c corporation, but it depends on a number of factors. It's always advised that you consult a tax professional or business consultant before selecting a structure.
What is an S Corp?
An S-corporation is a filing designation from the IRS that allows an LLC, or other underlying entity, to elect to be treated as a corporation. It leaves in place the same flexibility and easy management of the LLC but also allows/requires the business to treat itself as a more corporate type of entity. Some of these requirements include filing a separate return (1120S) from the personal return and paying yourself as the “shareholder” of the company as W2 salary that includes a reasonable compensation based on your industry, net income for the business, and what your services would fetch on the open market with another company.
The great thing about S-Corps is you can retain the independence and flexibility that you would enjoy as an LLC while also leveraging compensation and benefits that normally would be unavailable as a California sole proprietor with an LLC. Things such as 401(k) account matching and health insurance premiums are normally deductible in a large company but wouldn’t be offered to smaller LLCs with no payroll or corporate status.
Confused about LLC, S Corp, or C Corp?
Let Formations guide you to the best business structure, maximize your tax savings, and streamline your operations. Discover how Formations can help you set up an LLC, S Corp, or C Corp with ease.
