There are tons of decisions about starting your business that can seem overwhelming: What do you name it? How do you price your products or services? What kind of regulations do you need to follow?
In the midst of all these decisions, here are some solid answers about one of the most critical decisions you’ll make: which entity to choose for incorporating your business, and how it works. Read on if you’re wondering how to decide between LLC, S Corporation or C Corporation. We’ll talk about some differences between the various types of business entities, the risks and upsides of each and even what “LLC” stands for!
You’ve got questions, we’ve got answers. Here are a few key facts and terminology about the major types of business entities you might want to consider.
What LLC Stands for and How It Creates a Corporate Shield
LLC stands for “Limited Liability Company.” By incorporating your business as an LLC, you’ll get to enjoy certain limitations on your personal liability that can help mitigate the potential risks of owning a business.
Having an LLC or other legal business entity creates a “corporate shield” over your personal assets. This corporate shield separates your personal finances and legal identity from that of the business.
For example, if your business gets sued, that means the plaintiff is restricted from going after your personal assets in a court judgment. The corporate shield helps protect your personal assets (including your home, savings, personal vehicle, etc.) from the worst-case scenarios of business ownership.
C Corporations and Corporate Income Tax
The C Corporation is a business entity typically used by big or fast-growing businesses that are publicly traded. As of 2014, there were 26 million businesses in America, but only 5% of them were C Corporations.
A C Corp is also the only business entity required to pay corporate income tax. This is known as “double taxation.” C Corporations have to pay income tax twice: first on the company’s own income (corporate income tax) and then again when the shareholders’ dividend income is taxed on their personal tax returns.
S Corporations and State Taxes
The S Corporation is a business entity often used by smaller companies that do not want to issue public stock offerings. An S Corporation is limited to 100 shareholders, and none of the shareholders can be foreign nationals — they all must be U.S. citizens or permanent residents. America has 4.6 million S Corporations.
S Corporations are treated as pass-through entities at the federal level, but some states require them to pay state-level corporate income taxes. Currently, there are five states that impose taxes on S Corporations:
- New Hampshire
- Washington, D.C.
Some states require a business to file at the state level before they will recognize the company’s S Corp status:
- New Jersey
- New York
Another Option: Series LLC
A “Series LLC” is like a corporate umbrella of multiple LLCs. These companies are contained under one “parent” or “master” LLC, but they’re separated from each other for tax and liability purposes.
The Series LLC works similarly to a corporation with several subsidiaries. A Series LLC could be used to separate different product lines or services, or for a real estate company that wanted to create a separate LLC for each of its separate properties.
There are several states that recognize the Series LLC as a valid form of business entity, including:
- Commonwealth of Puerto Rico
LLCs and Taxes: What Is a Pass-through Entity?
LLCs and S Corporations are “pass-through entities” that do not pay income tax. Instead, all the company’s profits “pass through” directly to the personal income tax returns of their owners. There, they will be taxed at each individual’s personal income tax rate. In the U.S., 95 percent of businesses are pass-through entities that do not have to pay corporate income tax.
LLCs Can File Taxes as an S Corporation
With an LLC, you have the option to file taxes and be taxed as an S Corporation. This can give a portion of your income favorable tax treatment by reducing your tax liability for self-employment taxes. Be sure to consult with a professional tax advisor to make sure you are handling your tax obligations correctly.
If you have an LLC or C Corporation, you can choose to have the company file taxes as an S Corporation by filing IRS Form 2553, “Election By a Small Business Corporation.”
Do I Need to File a Schedule C?
One of the most important reasons for choosing a separate legal business entity when starting your company is that it can give you advantageous tax treatment at tax time. If you start a business but do not elect to form a legal business entity, all of your business income and expenses get reported on your personal income tax return’s Schedule C.
According to this article in Forbes, a Schedule C is “the single most likely type of tax return to be audited by the IRS.” This is the form used by most sole proprietors who do not elect to use another legal business entity. If you are an LLC who chooses to be taxed as a corporation, the Schedule C will also be how you report business income to the IRS.
Ready to start your business? At Incfile, you can learn more about which business entity is right for you, and we’re ready to help file the correct paperwork when you decide. We can even help file your taxes!