5 Tips To Making The Right Choice: LLC vs S-Corp vs C-Corp

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This is probably the most common question for every new entrepreneur and an important one to get right. Let’s start with why you need to form a business entity. The two main reasons are to protect your personal assets and to maximize your tax savings, meaning how much money you keep in your pocket. WARNING this article will not give you an answer. It is designed to give you the decision making format to help you choose the right entity for you.

1. HOW MANY OWNERS WILL THE BUSINESS HAVE?
Will it have 1, 2, 200?

LLC: A LLC can have any number of owners although widely held companies that plan to offer public shares will be better off as a C-Corp

S-Corp: S-Corps are limited to between 1-100 owners.

C-Corp: C-Corps are ideal for widely held companies where ownership interest will be traded frequently.

2. WHO WILL BE THE OWNERS OF THE BUSINESS?
Will they be individuals, corporations, LLC’s, non-US citizens or trusts?

LLC: A LLC can have individuals, other corporations or LLC’s non-US citizens and trusts as owners of the LLC. Also LLC’s can have various classes of equity owners.

S-Corp: Is limited to no more than 100 owners and they all have to be either individual US citizens or resident aliens or trusts.

C-Corp: Just like LLC’s the C-Corp has no restrictions on who can be an owner and can have various classes of stock ownership.

3. HOW WILL YOU FINANCE THE BUSINESS?
Will it be your own money, loans from friends and family, bank loans, outside investors, or venture capitalists? NOTE: Raising money is serious business and involves using an experienced business attorney who can help you navigate the strict world of SEC laws and regulations.

LLC: Because LLC’s have no restrictions on who can be an owner they are also flexible when it comes down to whom they can accept money and investments from.

S-Corp: Again because S-Corps have ownership restrictions it also limits who can invest in an S-Corp.

C-Corp: If you plan on raising large amounts of capital from VC’s then it helps to know that VC’s prefer investing in C-Corps as opposed to LLC’s for various tax reasons.

4. HOW WILL PROFITS BE PAID OUT TO THE OWNERS?
Will you distribute profits to the owners as the money is earned or will you reinvest the profits in to the business? Let’s talk flow through taxation vs. double taxation

LLC: LLC’s are known as tax flow through entities meaning the LLC does not pay taxes on the profits earned. The profits flow through to the individual owners who report their share of the profits earned on their individual tax returns. This flow through characteristic is beneficial if you plan to distribute profits to the owners as the money is earned because you only pay taxes once. By the way, LLC’s have the option to choose whether to be taxed as a flow through entity or double taxed like a C-Corp.

S-Corp: The S-Corp is actually a C-Corp that has chosen to be taxed as a tax flow through entity and therefore is ideal if you plan to distribute profits to the owners as the money is earned. Also the S-Corp has specific self employment tax benefits and you should consult your accountant to learn more about these benefits.

C-Corp: C-Corp income is taxed first at the business level and again at the individual level if distributed to owners in the form of dividends. While this may sound like a bad deal it actually makes sense if you want the earnings to stay in your business and you want the flexibility of spreading earnings between the corporation and the owners.

5. HOW MUCH CORPORATE FORMALITY DO YOU WANT TO HAVE?
LLC: LLC’s are known for being the most flexible of the entity choices and the least formal. Owners have the freedom to dictate how they want to operate the company and how formal they want to make it within the boundaries of state law.

S-Corp: The S-Corp and C-Corp both have strict requirements to maintain their corporate status including adopting and maintaining bylaws, holding and documenting initial and annual meetings of directors and shareholders, issuing stock and recording stock transfers. Its is important to note that if you fail to maintain these corporate formalities you also lose the benefit of the corporate protection of your personal assets, meaning if you get sued they can go after your personal assets.

C-Corp: See above.

If this article helped to clarify your choice, great, if it didn’t, not to worry because at least you know what factors to consider and what questions to ask your lawyer.

As always post your comments or questions below so that I can help you along your business building journey.

About Author:

Mo Chanmugham, Esq

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Bio:
Mo Chanmugham, Esq. is a business attorney who specializes in working with entrepreneurs in the entertainment industry. After working for major record labels like Island Def Jam and Sony BMG he founded The Legal Studio to combine his passion for entertainment, personal development and entrepreneurship. His mission is to help artists and entrepreneurs reach their potential by designing businesses that align their personal and professional values to achieve lasting success. When he is not playing lawyer he is working on his own start up projects and dj’ing around NYC.

Connect with him here:

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3 Comments

  1. Steve

    February 24, 2011 at 3:24 am

    This was informative. Great read for aspiring entrepreneurs.

  2. Paige Suda

    October 6, 2011 at 11:30 am

    Hi, Nice job! I saw this really great post today.

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