April 15, 2020
Comparing the Difference Between an LLC, S-Corp, and C-Corp
With so many different tax entities available to file under in the US, it can be difficult to know what advantages, limits, and disadvantages are within each option. Here is a quick outline of the differences between the major business designations available to taxpayers:
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. 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 just 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 a taxable event.
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.
Also known simply as “corporations” this is a company type that comes with a lot of personal liability protection for the owners but also a lot more restrictive handling of the company. To quote the Supreme Court justices 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.
An S-corporation is a filing designation from the IRS that allows an LLC to “elect” to be treated as a corporation (a “sort-of” corporation as it’s known around the Formations office). 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 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.
Learn how an S-Corp can save you on your taxes with Formations.Speak to one of our experts