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A limited liability company is a popular choice for small business owners who want a more formal business structure than a sole proprietorship or partnership. An LLC helps the business owners limit their liability for business obligations. Compared to a corporation, an LLC is flexible in the way the business is run and profits are distributed. In some states, LLCs have less strict record-keeping requirements than corporations. LLCs are also flexible in their tax status. By default, an LLC is taxed in the same way as a sole proprietorship or partnership. If you’re an LLC owner who works in the business, the Internal Revenue Service (IRS) considers you self-employed. You’ll file an LLC tax return on Schedule C of your personal return, and you’ll pay self-employment taxes and income taxes on your share of the company’s profits. But LLCs can also choose to be taxed as a corporation. Some LLC owners save money by electing S corp. tax status.

Not all businesses are eligible to be taxed as S corporations. You must meet the following requirements:

• You must be a U.S. business
• You can’t have more than 100 owners
• Owners can be individuals and certain types of trusts and estates, but S corps. cannot be owned by partnerships, corporations, or non-resident aliens
• There can only be one class of stock

S Corp. Disadvantages

For most small businesses, there are few drawbacks to S corporation taxation. Depending on your business, switching to an S corp. may mean filing additional tax forms or setting up a payroll system. If your company isn’t making much money, these additional hassles may outweigh the benefits. An S corp. may also not be the right choice if you plan to bring in outside investors or retain profits in the company bank account. In these situations, a C corporation is sometimes a better option.

C corps are separately taxable entities. They file a corporate tax return (Form 1120) and pay taxes at the corporate level. They also face the possibility of double taxation if corporate income is distributed to business owners as dividends, which are considered personal taxable income. Corporate income tax is paid first at the corporate level and again at the individual level on dividends.

C-Corps can have any number of shareholders from anywhere in the world, while S-corps must have 100 or fewer shareholders, all of whom must be U.S. citizens. Additionally, S-Corps cannot be owned by other S-Corps, C-Corps, LLCs, or trusts, which could make the business difficult to sell in the future.

While C-Corp status allows for large-scale growth, and the flexibility to sell the company in the future, the S-Corp shareholder limitations may be beneficial for businesses who want to stay small and closely held

Yes! Deciding on a business entity type isn’t as glamorous as deciding colors for your logo, but it’s just as important. The entity you choose—whether it’s an “S” corporation, LLC, or sole proprietorship—comes with longstanding tax implications, both good and bad. Our tax consultants can help you evaluate the pros and cons of each one, so you can choose the most advantageous entity type for your business.