Choosing the right entity can be one of the most important decisions a business makes. Business owners and investors may find themselves asking which to pick, LLC vs Corporation. To help make your decision a little easier, we’ve compiled a list of helpful comparisons that will teach you the basic differences among entity types.
- Who Should Use Which Entity?
- A Chart of the Differences between LLCs, C Corps, S Corps, Sole Proprietors and General Partnerships
- 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 higher 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.
LLC vs. Corporation Chart of Benefits
|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 – LLC vs C Corporation vs S Corporation
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. The employees, including you as the owner/shareholder, will also not pay taxes on the value of those benefits. The new tax reform bill reduced the amount that C Corporations are taxed. It made a permanent 21% corporate tax rate effective in 2018, representing a 40% decrease over the previous rate of 35 percent.
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. The new tax law changes this for some at certain income levels. Business income that passes through to an individual from a pass-through entity may be taxed at individual tax rates minus a deduction of up to 20% that may bring the rate lower. Consult with your tax lawyer on these issues. The new tax law is very complicated.
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.
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. Work with your tax advisor on which method of taxation is best for your specific situation.
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 shareholders, and they can only be of one type (i.e. just common).
An LLC issues membership certificates, which can be owned by both domestic and foreign persons, companies or trusts.
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, Utah, 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.
The new tax law provides advantages for foreign owners doing business in the U.S. Work with your advisor on the best strategy.
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.