How to choose between becoming an LLC, S-Corp or C-Corp

When starting a company, there are soooo many questions that are far more complicated to answer than “Should I become an LLC, an S-Corp or a C-Corp?”

But choosing the correct corporate structure for your company has long-lasting implications, so it’s best to get it right. Fortunately, it’s not complicated. In fact, it’s pretty simple. Just follow the flow chart below and you’ll end up with a good idea of the ideal structure for you:

(First a disclaimer: I’m neither an attorney nor an accountant. This information is based on my discussions with many attorneys and accountants over many years and on my own experience in setting up companies as all three structures.)

Infographic - how to decide between LLC and S-Corp and C-corp

Now, some explanations so you understand why the chart flows this way:

  • LLC:
    • Pretty much every company starts out as an LLC, and then you elect to become an S- or C- corporation.
    • You’d become an LLC if you didn’t plan on making more than $50k-60k net profit per year and the company will not have investors, but could have a few partners or just be a single person.
    • WHY: because as a member of the LLC, you cannot pay yourself a wage/salary, but you are required to pay federal employment tax (about 15.2% as of this posting, plus any state taxes depending on where you live) on your share of the net profit.
  • S-Corp:
    • You’d become an S-Corp if you started making more than $60,000 net profit per year.
    • WHY: The S-Corp election requires you, as an officer, to take a salary. By doing so you are not required to pay employment tax (15.2% at the time I originally wrote this) on the remaining profit.
      • Meaning, if your company was making $80k in net profit, you could take a “reasonable” salary of $45,000 and pay employment tax on that, and the remaining $35,000 would be taxed at a lower rate as a distribution
      • But, any and all profits (or losses) will show, on paper, as flowing through the officers, so even if you leave some of that profit in the company as operating/growth capital, you’re still going to pay taxes on it in the year it was earned, whether or not it actually makes it to your personal bank account.
    • You will have the added expense of a payroll service to administer your salary (I’ve used ADP because I’ve got better things to do with my time, and it’s not something I want to mess up). Between payroll and the tax return, there is an additional $2,500-$3,000 of operating expense for an S-Corp, but as your income grows the tax savings can offset this. Regardless of whether you become an S-Corp, you’ll start as an LLC and elect to become an S-Corp.
  • C-Corp:
    • You’d become a C-Corp if you plan on going public, otherwise don’t do this because you’ll pay taxes on your net profits twice – first as the corporation, and then on any salary you take from the company. And the filings are more involved, which means more expensive.
    • Or, you might want to become a C-Corp if you start making obscene amounts of money, because with a C-Corp, profits and losses stay in the company. With an S-Corp, if you’re making a LOT of money, then a LOT of profits may flow through to the owners…on paper.
      • Meaning, you might show that you took a lot of profit, but if you left that money in the company as operating or growth capital, it could create a big tax consequence without actually giving you the money to pay those taxes. If you want to avoid that.
      • Converting to a C-Corp avoids that tax consequence, but you’ll be paying taxes twice since the C-Corp is taxed as its own entity, so…pros and cons.

Missing from this is the option for becoming a Sole Proprietor. I don’t recommend it, here’s why: The benefit is that you don’t have to do anything up front, just claim revenue and expenses on a Schedule C on your personal tax return. The downside, according to my accountant, is that Schedule C is one of the most frequently audited returns, which is reason enough.

That, and there is no legal separation between you and the business as a Sole Proprietor, so if someone sues “the business”, it’s you and all of your personal world that’s up for grabs. An LLC provides separation between the two and better protects your personal assets.

If you’d like to dive a little deeper, this article from Entrepreneur describes nuances that may affect your decision making process, and this one from the SBA provides an overview of every option. Generally speaking I start all of my companies as an LLC, switch to an S-Corp when it makes sense financially, and would only ever become a C-Corp if I was taking the company public or needed to amass lots of or various classes of investors.

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