Which Business Entity is Best?

So, you’ve already read Should I Incorporate My Business? and What Are The Benefits of Incorporation? -- and you’ve decided to incorporate.


Business meeting

Now you move on to your selection of business entity. You want to know which business entity type is best for you.


For our purposes I’m only going to discuss three kinds of business entity: The C-Corporation; S-Corporation; and LLC. [Note that since an LLC is not a corporation, you technically don’t “incorporate an LLC.” Instead you “form” and LLC. But, you’ll see that an LLC is treated very similarly to a corporation.]


Let's compare these 3 forms of business entities:


  • C-Corporation -- This is the big one. That’s a corporation with all the bells and whistles. If you have a C-Corporation, you can take advantage of all the corporate tax benefits available. Frankly, I have never formed a C-corporation so I don’t have first-hand experience with them. But, suffice it to say if you have significant income from your business you will almost certainly be best off forming a C-Corp. By “significant income” I mean enough that you might be able to afford to pay for health benefits or a retirement plan for you or your employees. If you are "there," you really should just stop reading this and go see a good tax lawyer or CPA. The fee you pay them will be returned to you many times over in tax savings. The disadvantage of a C-Corporation is that it is more formal and requires more complicated tax filings. You have more requirements to hold shareholder meetings; keep corporate minutes, etc. Another potential disadvantage is double taxation. C-Corp. profits are taxed once at the corporate level and again if distributed as dividends to shareholders (including you). Of course, there are ways to lessen or even eliminate this problem, and often corporate tax rates are lower than personal rates -- but all of that gets into complicated tax issues that are beyond the scope of this article. Again, if you are making significant money, you likely should go with a C-Corp; but go see a tax professional ASAP (and before deciding).


  • S-Corporation -- It is simpler to run an S-Corporation than a C-Corp. The requirements discussed above are not as formal. The tax filings are much simpler because it is a “pass-through” entity for tax purposes. This means that any income or loss the S-Corp. makes passes through directly to its shareholder. This avoids the “double-tax” issue that C-Corporations face. Also, because income passes directly to the owner(s), you can avoid paying employment taxes (Social Security, Medicare) on that income. With a C-Corporation you can’t do that. You have to either pay income to the shareholder as a dividend (hence double taxation) or as salary (hence payment of employment taxes – by both the corporation and the employee (so, currently 12.7% combined total in the US). And, losses can’t be passed on to the shareholders at all – without dissolution of the corporation. Having said all that, even with an S-Corp, if you are making money, you do have to pay yourself a “reasonable salary” which will require paying those same employment taxes. But, at least once a reasonable salary is paid, above that the income can flow directly to you, free of employment taxes.


  • LLC -- I formed my first business as an S-Corp. (simply by filing an “S-Corporation election” with the IRS). I knew I would have losses my first couple years and wanted to be able to claim them on my personal tax form. An S-Corp or LLC was the only way to do that as both are “pass-through” entities. I went with an S-Corp because it seemed simpler. All I needed to do was file an “Articles of Incorporation” with the state. After that, the rules were pretty much set. I was going to own the company with my wife as equal shareholders; didn’t anticipate adding any other shareholders; so, the S-Corp seemed the way to go. However, after about 18 months, I wanted to add a new partner. The problem was I only wanted him to share in part of the business; not all of it. With an S-Corp you can’t do that. You are limited to 35 shareholders (no problem there) but also each shareholder has to share equally in the corporation. That was the problem. And, this is the benefit of an LLC. It is a bit more work to set up initially because of the operating agreement. However, in the long run it allows for more flexible arrangements. So, my second company was an LLC. Tax-wise, you can elect to have your LLC treated as a partnership and thus have profit and/or loss pass through the same as an S-corp. So, you can avoid the double-tax issue that a C-Corp has. The biggest disadvantage with an LLC is that it can’t go public. So, if you ever want to sell it you have to sell to a private buyer or re-organize as a corporation. If you are planning an IPO down the road – you don’t want an LLC.


A common question is: "Can I incorporate it alone?" The answer is: "Sure." You can have a single member LLC or be the sole shareholder of a corporation. No problem. But, you will need to check your state rules regarding whether someone else (or some other entity) has to serve as the registered agent.


So, what kind of business entity is best for you? Like most things, it depends. Hopefully, I’ve given you some things to think about. If you still have questions, you might want to check out the resources at "Legal Zoom" or consult with a lawyer. If so, check out the links in the ads to the right.


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