Types of Corporate Entities: LLC, S-Corp, and C-Corp

Your business can be as small as a one man army or a corporate behemoth. Whatever it is, it starts with some intelligent decisions and a little bit of paperwork. The three prominent types of corporate entities for people starting a business with are an LLC, an S-Corp and a C-Corp. You need to incorporate your business to make it recognized as a separate entity in the eyes of the law. This is the very first ‘important decision’ you need to make.

Some of the questions that might boggle your mind are: how should you decide which corporate entity you should go for? Which business entity would work best for you? How does an LLC differ from an S-Corp or a C-Corp or vice versa? What are the basic points of differentiation among the three of them?

Whether you have purchased an existing business or want to start fresh, you must first decide which business entity you should register with. Though there are various aspects in which these three business entities differ from each other. The extent of liability and tax implication involved are the leading deciding factors for each entity type. Other factors include the the ease of raising funds and the set-up cost involved and legal overhead. Making a well-thought and a well-informed business entity decision is among the best investment you can make for your business. Ensure that you analyze the advantages and disadvantages of all the three forms of business entities: LLC, S Corp or C Corp, and go with what best suit your goals.

A Detailed Look at the Three Types of Corporate Entities: LLC, S-Corp, and C-Corp

To incorporate your business as an LLC, S-Corp, and C-Corp in Delaware, you first need to file the appropriate documents with the state agency. These documents include the articles of organization for LLCs and the articles of incorporation for the corporations. Here are the details for each:

Limited Liability Company (LLC)

A Limited Liability Company (LLC) is a corporate entity that combines the characteristics of a Corporation and a Partnership/Sole Proprietorship. The members of an LLC enjoy limited liability and cannot be held for the debts of the company. In another word, business owners stand to lose only what they have invested into the business. For example, if the company is sued for any reason whatsoever, and the resulting judgement is more than what the company can afford, the members of the LLC aren’t personally liable to pay the judgement or make up the difference.

Another major characteristic of an LLC is ‘flow through taxation.’ This implies that the profits are passed on to the owners to be reported on their personal tax returns and avoids double taxation. For example, the profits of an LLC are distributed to the owners are are taxed as their individual income. However, the LLC, being an entity, is not subject to direct taxation and thus, is not taxed for the revenue earned.

LLCs offer more flexibility than a corporation and is suitable for companies having only one owner. If you are looking for creating an LLC in Delaware, it is very easy. All you need to do is file the proper Certification of Formation with the Delaware Secretary of State. About 2/3rd of all companies formed in Delaware are LLCs!

The members of the company draft the Operating Agreement which contains the structure of the company and the rules governing the members of the company. These rules can be amended if the need arises.

An LLC has a low start-up cost and offers an affordable Franchise Tax (A franchise tax is a tax charged by a state to corporations and LLC’s for the privilege of incorporating or carrying out business in that state. It, like income tax, is generally imposed annually – currently a flat fee of $300 annually as of 2014). People who want to start a company but have no intentions to go public, opt for this type of corporate entity.

An LLC might be the right type of business for you if:

  • You want a business entity that offers limited liability to its members
  • You need flexibility to share the profits between or among the owners
  • You want to go for an entity offering flow through taxation
  • You want to be flexible in preparing your accounting (LLCs don’t require the use of accrual accounting)
  • You want flexibility in the structure of the management of the business
  • You want to keep the ongoing formalities and documentation requirements to the minimum (e.g. a corp requires an EIN (Federal Tax Identification Number, annual directors meeting and notes, etc.)
  • You want to avoid the meeting requirements imposed on Corporations ‘as mandatory’ by the State.

C-Corporation

A corporation is a separate legal entity set up under the state law offering limited liability to its members. This implies that the owners cannot be held liable to the creditor’s claim – like an LLC, they can only lose up to the amount of their individual investment.

Incorporating your business entity automatically registers you as a ‘C-Corporation.’ A C-Corp is a separate tax payer, which implies that the corporation itself is taxed for its income and expenses. If owners receive the profits as dividend, they need to pay a separate tax on this dividend, leading to ‘double taxation.’ – i.e. the corporation pays taxes for it’s profit, and the individuals that get paid from the corporation also pay personal income tax.

This is why many small to medium scale business don’t opt for C-Corporations (but will do S-Corps, more on that later). Due to the flexibility it provides on the share and membership structure, large companies favor this type of business entity. A C-Corporation can have any number of members with varied levels of voting privileges among them. This helps the C-Corps grow and expand their shares easily. A C-Corp is fairly easy to form (though not as easy as an LLC) and easy to sell.

C-Corps and S-Corps are actually two different forms of the same type of Corporation, so they both have the same management and regulation compliance requirements.

A C-Corp might be the right type of business for you if:

  • You want a business entity that offers limited liability to its members
  • You want easy ability to divide ownership
  • You want relative ease of use in Delaware (Delaware has a series of tax and regulatory laws- specifically the Delaware General Corporation Law – that are more advantageous to the corporation than almost anywhere else in the country.)
  • You want to have the ability to issue stock options with different classes of stock
  • You want to be able to sell your business easily
  • You want to have tax benefits on sale (as an owner)
  • You want flexibility in sharing profit among the owners
  • You need venture capital for financing
  • You want company earnings to stay in your business so that it can grow
  • You want flexibility in fixing the salaries for owners/employees and provide substantial health and medical benefits
  • You prefer lowering the risk of IRS audit exposure (as there is a higher audit rate for business income that is reported solely on Schedule C of Form 1040 – US Individual Income Tax Return)

S-Corporation

Technically, S-Corporations are not legal business structures. An S-Crop is actually a tax election granted by the IRS – one that you have to apply for. S-Corporations are meant for small to medium scale businesses and thus, cannot have more than 100 members. The members enjoy limited liability and are only liable to the amount of their individual investment i.e. they don’t owe any personal liability to the business debt.

To create an S-Corporation, the owner must form a Delaware general (C-Corp) or close corporation (LLC) and then file Form 2553 with the IRS within 75 days of the date of formation. Once the application is approved by the IRS, the S-Corporation will need not pay the US federal income tax, but the owners/shareholders pay the taxes according to their share in the Delaware S-Corporation. So, unlike C-Corporations, S-Corporations do not pay tax. Instead, the shareholders or owners are taxed for on the amount of income/dividend they receive.

However, a Delaware S-Corporation must perform a lot of functions to ensure compliance concerning issue of stocks, passing of bylaws, holding shareholders meeting and maintaining the correct Minutes of Meeting, etc.

An S-Corp might be the right type of business for you if:

        • You are looking forward to the benefits of being a Corporation along with the advantage of the ‘pass-through taxation.’
        • You want to enjoy the flexibility of fixing the salaries for the employees/owners.
        • You want to enjoy the flexibility of maintaining accounts. Until the S-Corporations have inventory, they need not use the accrual method of maintaining accounts.
        • You are Ok with having only one single class of stocks but with different voting rights.
        • You prefer lowering the risk of IRS audit exposure (as there is a higher audit rate for business income that is reported solely on Schedule C of Form 1040 – US Individual Income Tax Return)
        • You want to receive both salary and dividends leading to a reduction in the overall tax bill.
        • If you anticipate going public in future and look for an option with ease of conversion, S-Corporation is for you. It is easy to convert an S-Corporation to a C-Corporation as compared to converitng an LLC into a C-Corporation.

C Corp, S Corp, and LLC in a Flash:

        • Liability: LLCs, C-Corps, and S-Corps offer personal liability protection. The liability is limited to your investment and your personal property is not at risk (in most cases)
        • Taxation: LLCs and S Corps both offer ‘Pass-through taxation’ while C-Corps is a ‘separate taxpayer’, leading to double taxation.
        • Business Scale: Small to medium scale businesses go for S-Corporations and LLCs while the big businesses opt for C-Corporations.
        • Ability to take public: C-Corporations can go public to raise funds. S-Corporations, when going public, become C-Corporations. LLCs can be incorporated without tax and then taken public.
        • Ability to Change Structure without Tax: The C-Corporation and S-Corporation don’t have the ability to Change Structure without Tax, but LLCs do have.
        • Flexible Charter Documents: The C-Corporation and S-Corporation need to follow strict compliance with the rules and regulations laid down by the State, while the LLCs enjoy flexibility in charter documents.

Delaware General Corporation Law provides more advantages to the Corporations than almost anywhere else in the US. This makes Delaware the most preferred destination for the companies and investors to incorporate. The State gets the revenue, and you get the ease of relaxation in taxation and regulations!

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