As you meet with your accountant this tax season and consider the swirling number of legislative changes over the past few years, you may be looking at your business with a fresh set of eyes and realizing that it may be time for a change in the structure of your business.
This decision could be due to a number of reasons, from a change in the ownership structure to wanting more liability protection or maybe there have been recent tax changes that would make it more advantageous to change the structure of your company. Whether you are a sole proprietor, a general partnership or a start-up ready to take the next step, the question now becomes should your company be structured as a Limited Liability Company (LLC), a C Corporation (C Corp) or an S Corporation (S Corp)? Most people opt to Start LLC, but either option can be valid.
Overview of LLCs, C Corps and S Corps
An LLC is an entity structure that offers the protection of limited liability similar to a corporation, while allowing the owners more of the flexibility of a partnership. Like a partnership, an LLC allows the owners to participate in the management of the LLC and allows for more flexibility in the profit sharing, as the owners decide who has earned what percentage of the profits or losses. Another benefit of forming an LLC is that it is easier to operate than a corporation, since the requirements to operate and maintain an LLC are less complicated and thereby less costly than when operating a corporation. One thing to keep in mind is that with an LLC, the owners are subject to self-employment tax on LLC income.
A C Corp is another type of entity structure that owners may choose to form. Since it is formed as a corporation, the owners have limited liability and are not liable for the corporation’s debts, thereby protecting their personal assets from creditors. Typically for tax purposes, the owners’ stakes in the company are treated as shares of stock. A C Corp is taxed at the corporate level and again when distributions are made to its owners. With a C Corp, the owners do have control of the business, but they must elect directors, who then elect officers. The directors handle the major decisions, and the officers will oversee the day-to-day decisions.
While it is more involved to operate a C Corp, there are benefits. One benefit of a C Corp is that there is no limit to the number or types of owners; whereas, with an S Corp you are limited. Another benefit of a C Corp is that there can be multiple classes of stock for different levels of ownership. This flexibility makes it a top choice for companies looking for outside investors. Additionally, employee-owners are able to receive healthcare and other fringe benefits, and the corporation can deduct those costs.
An S Corp structure is available to corporations that make an election to be treated as such. The number of owners in an S Corp is limited to 100, and there are limits to the type of owners of an S Corp. Unlike an LLC and a C Corp, with an S Corp, there is only one class of stock for its shareholders; however, there can be differences in the shareholders voting rights. A benefit to operating as an S Corp versus a C Corp is that you eliminate the double taxation since there is generally no tax at the corporate level, but rather the owners are taxed on their allocated profits and losses.
The tables below provide a high level comparison of LLCs, C Corps and S Corps from formation to termination of entity or owner interest at the Federal level.
Comparison of LLCs, C Corps and S Corps
Note: These comparisons do not consider state implications.
(Excerpts of table derived from AICPA http://www.aicpa.org)
| Factor | LLC | C Corp | S Corp |
| I. Formation | |||
| A. Method | Articles of Organization filed in state recognizing LLCs | Articles of Incorporation | Articles of Incorporation |
| B. Owner Eligibility | |||
| 1. Number / Types of Owners | No limitations | No limitations | 100 / Certain individuals, estates, charities, ESOP, trusts and S Corporations |
| C. Capital Structure | |||
| 1. Equity | No limitations (multiple classes) | No limitations (multiple classes) | Only one class of stock (can have voting right differences) |
| D. Status Determination | |||
| 1. Election by Entity | None, unless corporate status is elected | No election requirements | Required election |
| II. Operational Phase | |||
| A. Tax on Income | Owner level | Corporate level | Owner level |
| B. Allocation of Income/ Deductions | Permitted if substantial economic effect | Not permitted (except through multiple equity structure) | Not permitted (except through multiple equity structure) |
| C. Character of Income/ Deductions | Flow-through to members | No flow-through to shareholders | Flow-through to shareholders |
| D. Net Operating Losses | Flow-through to members (limited to basis) | No flow-through to shareholders | Flow-through to shareholders (limited to basis) |
III. Owner Compensation Arrangements |
|||
| A. Fringe Benefits | Limited participation for owners | Shareholders-officers qualify for benefits | Shareholder officers qualify for benefits (medical premiums for greater than 2% shareholders treated like partnership guaranteed payments) |
| B. Retirement Benefits | Certain limits applicable to partners | Shareholder-officers included in qualified plans | Certain limits on shareholder-officers |
| C. Reasonable Compensation Limits | Applicable where capital is a material factor | Applicable to shareholder-officers | Applicable to shareholder-officers |
| D. Payroll Taxes | Active member subject to SE taxes on all income. No SUTA or FUTA. | Shareholder-officers subject to payroll taxes only on compensation | Shareholder-officers subject to payroll taxes only on compensation |
Next Steps
Choosing how to structure your company is a big decision, and there are many things to consider. Erock Tax + Financial Planning is here to help you create the best strategy for you and your company’s goals. Should you have any questions about how to structure your company, please feel free to contact us at (781) 247-5569.
