LLC vs. C Corp: What’s the difference for my taxes?
Starting up a new business is an exciting time with lots of to-dos on your list. One important first step is to identify the right business entity for your venture.
As you contemplate which path to take, you might come across two options: a limited liability company (LLC) and a C Corporation (C corp). The difference between a C Corp and LLC is not clear cut, however. Both terms refer to state business designations. For federal taxes, corporations always file corporate tax returns, but an LLC has more flexibility in how it’s taxed.
C Corporation vs. LLC: What’s the difference?
Before you identify the structure that’s best for your business, let’s define them:
What is an LLC?
A limited liability company, or LLC, is an entity set up under state statutes.
This business structure combines the flexibility and lack of formalities of a sole proprietorship and partnership, with the limited liability protections of a corporation. That’s right—it provides legal liability protection for its owners, or members—so you can’t be sued for personal assets.
But, an LLC is not an IRS-recognized business structure for federal taxes. You have to choose between a default tax method or elect to be taxed as a specific IRS-recognized business entity. (In fact, you can even elect for your business to be an LLC taxed as a C Corp.)
An LLC may have a single-member or have multi-members.
What is a C Corporation?
A C Corporation is a legal and IRS-recognized business entity that’s best for businesses looking to keep its profits in the business. A C Corporation pays tax twice: first as income tax at the corporate rate, and secondly as shareholders when they pay income tax on dividends they receive.
C Corporations must disclose performance in an annual report and follow other corporate formalities. A C Corporation’s legal structure limits an owner’s financial liabilities, similar to an LLC.
Most large corporations in America are taxed as C Corporations. Corporations may also elect to be taxed as an S Corporation, and many small businesses choose this election.
How are C Corporations taxed?
A C Corporation is acknowledged as a separate taxpaying entity from an individual. It manages the business, realizes net income or loss, pays taxes and dispenses profits to its shareholders.
Here are a few facts about C Corporations from the IRS:
- It generally takes the same deductions as a sole proprietorship to determine taxable income.
- It can make special tax deductions.
C Corp vs. LLC taxes
C Corporations file taxes using Form 1120. Profits are not passed through to the shareholders’ individual tax return. However, a corporation might pay dividends to shareholders or the shareholder may sell the stock for a gain—both types of distributions would be reported on the shareholders individual return.
With an LLC, you file taxes using a variety of tax forms, depending on what election you choose.
Do these details already make you feel overwhelmed? Block Advisors is here to help you make sense of the significant tax considerations for this important business decision. As part of your tax prep with of one of our small business certified tax pros, you can get insight into the potential business entity tax classifications and how they could impact your taxes.
Pros of C Corps vs. LLCs
First, we’ll dive into C Corps. There are a few benefits of C Corporations, including:
- There’s no liability for non-active stockholders. (Non-active shareholders are common in family businesses.)
- There’s no restriction on ownership. This means that there aren’t restrictions on the number of investors, allowing for ample growth.
- Ownership can be transferred through the sale of stock.
- C Corporations are a separate entity from stockholders. So, its taxed on its profits.
- This type of entity allows for fringe benefits (non-monetary compensation for work) for employees, owners or officers.
- Shareholders have a reduced tax rate on capital gains on the sale of qualifying small business stocks. The corporate tax rate is 21%.
- With C Corps, anyone can own shares including business entities and foreign individuals.
- C Corps have perpetual existence. This means there’s no end-date to operating a C corp. An LLC may have a limited lifespan under state law, and members may be able to choose if the LLC will end on a set date. You can also elect to have a perpetual LLC.
- C Corps can raise capital by issuing or selling stock. Additionally, the transfer of stocks is not difficult with this form of business structure.
In addition, it’s considered a good structure for businesses with:
- Ownership in multiple other business entities
- Significant exposure to liability
- the intention to exist forever
Cons of C Corps
Disadvantages of C Corps include:
- Double taxation of profits – A C Corp’s profits are taxed as business income, and then taxed again to the shareholders when dividends are distributed, creating a double tax. A C corporation doesn’t get a tax deduction when it distributes shareholder dividends.
- Shareholders can’t deduct any loss of the corporation to reduce their overall taxable income at an individual level.
- C corporations can be complex and expensive to create and maintain due to formalities such as the drafting of bylaws by an attorney, electing a board of directors and executives and the issuance of stock, just to name a few.
- They require observing corporate formalities such as regular board of directors’ meetings and minutes. Plus, there are additional tax returns to file annually.
Wondering how LLC vs. C Corp stacks up? In summary, LLCs are easier to form and operate from a tax perspective. But, if you’re looking to grow your empire, then a C Corp might be for you. Learn more above the benefits and drawbacks of LLCs from a tax standpoint.
More help deciding between an LLC vs C Corp
Choosing the best business structure for your small business shouldn’t be a decision you take lightly. It affects your tax obligation, ability to raise funds, share distributions, and more tax-related matters. What we outline in this article are only some of the many factors to consider, and this is not intended to be legal advice or specific to any situation. We recommend you seek the advice of an attorney about the implications of entity selection.
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