- Who Should Use Which Entity?
- The Tax Breakdown of Each Entity
- Shareholders and Owners
- Asset Protection of Each Entity
- What’s Best for Foreign Investors?
LLC vs Corporation: Who Should Use Which Entity?
C Corporations are great for businesses that sell products, have a storefront and have employees. Businesses that offer services may find the taxes of a C Corp to be too high because of specific tax laws applied to Personal Service Corporations (PSC). It’s also advised not to hold appreciating assets in a C Corp because of the tax treatment of asset sales.
S Corporations are a good choice for people who would like the protection and structure of a corporation, but would be classified as a PSC by the IRS. They are also great for businesses that have significant start-up costs because of their flow-through taxation.
LLCs are great for people who want an entity to hold real estate or other appreciating assets. They are a popular choice for investors and entrepreneurs because of the flexible taxation and great asset protection.
|C Corp||S Corp||LLC||General Partnership||Sole Proprietor|
|Owners have limited liability for business debts and obligations|
|Created by a state-level registration that usually protects the company name|
|Business duration can be perpetual|
|May have an unlimited number of owners|
|Owners need not be U.S. citizens or residents|
|May be owned by another business, rather than individuals|
|May issue shares of stock to attract investors|
|Owners can report business profit and loss on their personal tax returns|
|Owners can split profit and loss with the business for a lower overall tax rate|
|Permitted to distribute special allocations, under certain guidelines|
|Not required to hold annual meetings or record meeting minutes|
The Tax Breakdown of Each Entity
A C Corporation has the widest range of deductions and expenses out of all the various entity types. This is especially true in the case of employee fringe benefits. If you own a C Corporation, you can set up medical reimbursement and other employee benefits and deduct the costs associated with running these programs from your corporate taxes. It’s also worth noting that as a C Corporation you pay an initial rate of 15% on earnings up to $50,000.
While you have access to a wide range of deductions and the ability to set up fringe benefits without taxation, the biggest tax disadvantage of C Corporation is the “double-taxation” issue. Double-taxation can occur when a C Corp has a profit at the end of the year that it would like to distribute to its shareholders. The C Corp has paid taxes on the profit, but once it gets distributed to the shareholders, they also have to declare the dividends they receive on their personal tax returns at their own tax rate.
You may also want to consider an S Corporation if your company’s primary product is services to the public, as you will be taxed as a PSC with an initial rate of 35% instead of the 15%. The IRS does this to stop people from using a corporation to pay less in taxes for what is essentially a salary.
Want to learn more about the benefits of a C Corporation? Get the Full Guide to C Corporation Advantages and Disadvantage here.
S Corporations are what is called a flow-through entity (similar to an LLC). Unlike a C Corporation, an S Corporation pays no tax on the corporate level. The shareholders only have to pay taxes on the individual level. This can be beneficial in some cases, but shareholders who make a high income from distributions will pay higher taxes. As far as benefits are concerned, S Corps may still write off the cost of benefits, but shareholders who control more than 2% of the entity must pay taxes on the benefits they receive.
S Corporations are commonly used to avoid the PSC tax rate set by the IRS. A corporation is considered to be a Personal Service Corporations (PSC) by the IRS if more than 20% of the corporation’s compensation cost for its activities of performing personal services is for personal services performed by employee-owners and the employee-owner owns 10% or more of the stock. Personal services include any activity performed in the fields of accounting, actuarial science, architecture, consulting, engineering, health (including veterinary services), law, and the performing arts.
Since an S Corporation is a flow-through entity and shareholders pay taxes on the individual level, a modest salary with passive income may mean lower taxation. To determine what’s best for you and your business, you should always talk with your CPA or legal advisor.
LLCs can choose how to be taxed – either as a disregarded single member entity (where the tax reporting flows directly onto the sole owner’s personal return) or as a multiple member partnership. LLCs can also be taxed as an S Corporation or C Corporation. No other entity has this flexibility.
Shareholders and Owners
C Corporations allow for an unlimited number of shareholders, there is no limitation on who can hold shares and no restrictions on what types of shares can be held (such as preferred vs. common). A C Corp is perfect for a company looking to go public.
S Corporations are a bit more restricting. All shareholders of an S Corp must be U.S. citizens, and you can only have 100 shares issued, and they can only be of one type.
An LLC does not issue shares, but it can have multiple owners who all share a percentage of the company.
Asset Protection of Each Entity
C & S Corporations
A Corporation is an entirely separate and independent legal entity from its owners (or shareholders) and there is a separation between ownership and management. As such, the management and shareholders of a Corporation generally are protected from personal liability for the Corporation’s liabilities and obligations. Although shareholders of a Corporation may be liable for the amount they have invested in the Corporation, their own personal assets usually are protected. This limited liability feature also applies to directors, officers, and employees of a C Corporation.
There is one chink in the asset protection of a Corporation. If you own shares in a corporation and are sued personally (i.e. after a car wreck), a judgment creditor can reach your shares in the corporation. If you are the majority owner, the attacker now controls your business by virtue of share control. Nevada is the only state that extends charging order protection (as in an LLC) to corporate shares.
A Key feature of the LLC is charging order protection. In strong states like Nevada or Wyoming, if the owner of a business gets sued, an attacker can only get a charging order (a lien to the distributions of the LLC). If there are no distributions, the attacker gets nothing. The charging order in most cases is contingent on the entity having at least two owners, but Nevada and Wyoming have protections for the single member LLC.
It should be noted that in some states, like California, Georgia and New York, the court may still order a sale of the businesses assets.
Learn more about protecting your assets through incorporation here.
What’s Best for Foreign Investors?
If you are a foreign investor, the entity you choose will most likely be determined by your home country’s tax system.
C Corporations are a good to foreign owners for the same reasons stated in the sections above, but It may be more popular with countries that have similar taxation. For example, most Canadians prefer to use a C Corporation because the taxation of a C Corporation most closely resembles that of their home country. When the systems are closely related, it makes them easier to manage.
S Corporations are the only U.S. entity that cannot be used by a foreign investor.
In general, whether you’re a foreign real estate investor or one in the U.S., the limited liability company is the best entity. The LLC is great for both asset protection and has flow-through taxation, and they are affordable to set up and maintain. Since they have flexible taxation, they can be set up for easier taxation management too. Often Canadians will use an LLC taxed as a C Corporation for ease of use, and Australians use them as-is for real estate investment of their retirement monies. It’s always best to consult your accountant about which taxation system would best fit your business.
Visit our foreign investor page for more information on setting up an entity as a foreign investor.
Determining which entity is right for you can be challenging. You want to ensure that you are getting set up properly right from the start. If you need help figuring out what entity is right for your business, set up a free 15-minute consultation with our incorporation specialists.