C Corporations, or C Corps, are one of the most common types of legal business entities for starting a company. Many recognizable brands and everyday products are sold by C Corps. Major publicly traded corporations like Amazon or Apple are C Corps. When people think about incorporating their small business, the C Corporation might be the first option that comes to mind.
Recently, a different entity has become an increasingly common choice for startups and small businesses. Limited liability companies, or LLCs, are a business entity type with significant differences from a C Corporation. Depending on the goals of your business, the LLC might be a better choice.
Here’s what you need to know in order to make the best choice between C Corp vs. LLC for incorporating your new company.
Taxation Differences in C Corps and LLCs
Some of the biggest differences between these two business entities are their tax implications. C Corporations have to pay corporate income taxes where the corporation itself owes taxes to the government, and the corporation’s owner pays taxes a second time on any salary and dividends received from the business. This situation is called “double taxation,” which generally translates into a heavier tax burden for the business owner.
Legally speaking, a C Corp and its owner are distinct entities. This means that profits from the company are taxed according to corporate tax laws, and any dividends paid out to shareholders are subsequently taxed as individual income. Many C Corps use legally permissible techniques to alleviate the impact of double taxation on their business profits, and a new tax law that took effect in 2018 significantly reduced corporate tax rates for C Corps.
However, even with the various tax advantages for corporations, the complex tax structure of a C Corp might not make sense for many small business owners.
If you want to have a more simplified and flexible option to structure your business with tax time in mind, registering as an LLC might be a good alternative.
LLCs are treated as “pass through” entities for tax purposes, meaning that the LLC does not pay taxes; any taxable income from the business simply “passes through” to the owner and is reported on the business owner’s personal tax return. As such, the LLC is not obligated to pay corporate taxes to the IRS. All the profits are technically considered personal income. This negates the burden of double taxation on the business owner.
While avoiding “double taxation” may seem like an obvious advantage for an LLC, that is not always the case. Because of the “pass through” nature of the company’s profits, LLC owners must pay self-employment taxes on these profits in addition to their personal income taxes.
However, this is where LLCs have another tax-related feature that can give you an advantage at tax time: you can choose to have your LLC treated as an S Corporation for tax purposes. This can help you potentially reduce your self-employment tax liability.
All businesses are different and many tax laws vary state to state. Talk with a professional tax adviser to get a fuller picture of the tax implications for whatever business entity you choose.
Ownership Structures and Corresponding Requirements
Aside from taxes, another major difference between LLCs and C Corporations lies in the ownership structure. In general, C Corporations are hierarchical organizations. Power is divided between stockholders, officers and directors. Stockholders elect directors who make the “big picture” decisions for the corporation. The directors typically appoint the officers to run the day-to-day operations of the company. Stockholders with more shares are rewarded with more voting influence and higher stock profits.
A classic example of this stockholder ownership model is a publicly traded company, which might have millions of shareholders. If you want your business to grow to significant size, attract venture capital, and perhaps have an Initial Public Offering (IPO) and have publicly traded shares, you will need to incorporate your business as a C Corp.
However, along with offering higher potential for long-term growth, the C Corp also requires a higher level of complexity in regulatory compliance and reporting. C Corporations must appoint a board of directors, hold annual shareholder meetings and deal with various other aspects of being accountable to regulators and shareholders.
If your business is small, your goals are more modest and your strategic vision is not focused on being a fast-growing publicly traded firm, you might be better off avoiding the complexity of the C Corp structure.
This is another reason why many small business owners choose to form an LLC: it’s a flexible, adaptable business structure that can work well for many types of small businesses, with less regulatory compliance and paperwork than is expected for a C Corp.
LLCs are structured like a partnership (or a sole proprietorship in the case of a single member or married couple LLC), but with the same limited liability protection of a C Corp. Members — the term used for the owners of an LLC — effectively run the company and make all the business decisions.
For an LLC, the division of ownership, profit distribution and most other matters are decided by private agreement amongst the members. With an LLC, the owners make the rules in regards to profit distribution and power. Profits are typically — but not necessarily — divided proportionally to a given member’s investment.
In general, LLCs are usually a better choice for smaller companies where only a few owners and workers are involved.
Here are some other notable differences between and LLC and a C Corporation:
Meetings: LLCs are also not obligated to hold annual shareholder meetings, which are a requirement for C Corporations.
Paperwork: C Corporations typically require more ongoing paperwork, regulatory compliance, and higher administrative costs and formalities than LLCs in order to stay compliant with the law and maintain their corporate status.
Growth: C Corporations offer the owners the ability to partner with venture capitalists who want to invest in the business. Venture capitalists like to invest in C Corps because the corporations are allowed to issue different classes of stock to shareholders; this can help venture capitalists receive preferred shares, which can increase their profits as the company grows. If you ever need to raise substantial capital to scale your business, it might make sense to start a C Corp instead of an LLC.
Both of these business entities have distinct benefits, and what is right for your company may change with time.
As with all major business and financial decisions, it’s advisable to consult with legal and tax professionals in your state to determine which business entity is best-suited for your business and your bottom line. And remember: it’s not too late to change your mind — you can transition your LLC to a C Corp if you decide at some future point.
Ben Gran is a freelance writer from Des Moines, Iowa. Ben has written for Fortune 500 companies, the Governor of Iowa (who now serves as U.S. Secretary of Agriculture), the U.S. Secretary of the Navy, and many corporate clients. He writes about entrepreneurship, technology, food and other areas of great personal interest.