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When seeking to incorporate your business, you need to take into account multiple implications, from tax considerations to management options to ongoing operations to investment opportunities and more.
Most often, entrepreneurs end up choosing between C-Corporations and limited liability companies. Which of those is your best match? Below, we’ll show how those legal structures stack up to help you make your choice.
If you are going to set up a corporation, you’ll establish a C-Corp by default. To be clear, a C-Corp is not a type of legal entity, it’s rather a tax classification since it bears the name of the Subchapter C of the IRS Code.
A corporation is one of the oldest business forms meant to detach an enterprise from its owners, thus, splitting owner and company responsibilities, powers, and duties.
It gives more freedom to a company as a legal entity and ensures better protection for its owners as individuals.
Main C-Corp characteristics are as follows:
Separate legal identity: C-Corps are registered entities independent from their owners at a legal level. It means they have their own rights and commitments as legal persons;
Ownership and management divided: C-Corp’s ownership rights are stipulated and traced by shares. Company owners or shareholders can delegate control and strategic planning to the Board of Directors;
Formation implications: To establish a C-Corp, you will have to register a company statute with the state, compile business bylaws, and hold a few compulsory meetings to be recorded;
Limited personal liability: While the company stockholders will handle business losses to the number of their shares, they are not responsible for the company's debts and liabilities;
No strict rules for shareholders and stock: C-Corps are entitled to issue different classes of shares and place no restrictions on who can be a company shareholder;
Complex taxation: C-Corps pay corporate income taxes under IRS Form 1120. Meanwhile, shareholders are exposed to levies on dividends distributed to them.
LLC and Its Features
As compared to a C-Corp, an LLC is a relatively new structure that appeared as a response to rapid business transformations in the mid-1970s and got up steam at the end of the 1990s.
LLC embraces the features of corporations and disregarded entities to match various business conditions and situations. It’s a kind of hybrid framework that has taken the best of both worlds:
Legal independence: Similar to C-Corps, LLCs require state registration and exist as legal entities separate from their owners;
Quick and simple formation: With a lower level of bureaucracy and legalities to them, LLCs are really easy and fast to form. You’ll be able to do it on your own even if you are new to this;
Limited LLC owner liability: It’s yet another feature borrowed from corporations that adds great value to this legal structure by ensuring better independence and confidence for the LLC owners;
No business income tax: LLCs have adopted pass-through taxation from disregarded entities. Company profits are taxed after being distributed to the LLC owners under their individual tax rates;
An unlimited number of members: It’s one more feature LLCs share with C-Corps. A company can be established by a single member or co-owned by multiple members, with no restrictions on new ones.
C-Corp Pluses and Minuses
C-Corps have a lot to offer to certain business formats. At the same time, it’s not an ideal business model. To better understand how it might work for you, consider its strong and weak points in a side-by-side comparison.
Owner assets protection
Heavier tax burden
Loyal shareholder requirements
Higher formation and running costs
Lower maximum tax rates
Lack of personal write-offs
Diverse investment sources
More regulations to observe
Better scaling opportunities
Complex management structure
Owner assets protection: Shareholders are not liable for the company’s financial liabilities and commitments. Their personal property and funds will stay intact in a lawsuit against the company;
Loyal shareholder requirements: Any physical or legal person irrespective of its residency and country of origin could become a C-Corp shareholder;
Lower maximum tax rates: Meant to match the needs of businesses generating high profits, C-Corps offer lower income tax rates than individual rates (21% maximum corporate rate against a 30% personal rate);
Diverse investment sources: Corporations issue stock and can sell it to raise funds from investors. Meanwhile, C-Corps are also open to venture capital and institutional investors;
Better scaling opportunities: Startuppers would highly appreciate making use of accelerator and incubator programs. Intended to maintain business scaling, they give preference to C-Corps;
QSBS: Qualified small business stock is a benefit available only to C-Corps and allowing startuppers and investors to save on capital gains taxes.
Heavier tax burden: C-Corps are exposed to what is called double taxation since they have to pay taxes both at a corporate and a shareholder level;
Higher formation and running costs: C-Corps are quite expensive both to start and to run. Though expenses vary by state, on average, they stand on the higher end and amount to thousands of dollars;
Lack of personal write-offs: Shareholders are not entitled to remove losses from their individual tax reports;
More regulations to observe: C-Corps have quite a number of rules and formalities to follow to stay in good standing with the state;
Complex management structure: C-Corps have a quite strict multi-tier management hierarchy to maintain.
LLC Pluses and Minuses
Currently, LLCs are extremely popular among entrepreneurs-to-be and startuppers. And it’s not without a reason. This structure has a lot of benefits that feel inviting for smaller businesses.
Personal assets shield
Limited fund-raising opportunities
Fewer chances to retain profits
Fewer formalities to stick to
Personal assets shield: It’s only the LLC’s property and money that will be taken to settle the lawsuits against the company leaving owner assets intact;
Simple management: LLCs allow company owners to operate the business by themselves or together with hired managers, or delegate day-to-day management to hired directors;
Fewer formalities to stick to: LLCs are a breeze to organize and won’t take you much effort to maintain since there are only a few state requirements you’ll have to keep up with to stay compliant;
Tax options: Taxed as disregarded entities by default, LLCs are also entitled to be regarded as C-Corps or S-Corps for tax purposes.
Limited fund-raising opportunities: LLCs don’t issue shares which makes them less attractive to investors and limits their financial source options pertinent to corporate structures;
Fewer chances to retain profits: LLC profits will be taxed as personal owners’ incomes no matter if the distributions are made or not;
Self-employment taxes: LLC owners cannot be company employees unless it’s taxed as a corporation. Hence, they are considered self-employed and exposed to self-employment taxes;
LLC tax: Some states have a compulsory franchise tax for LLCs to be paid annually. The tax rate might jump high and considerably bump up your business's running costs.
C-Corps and LLCs: How They Differ
Both C-Corps and LLCs bring the credibility of independent legal entities and valuable liability protection. Yet, these structures differ in three key areas that distinctly set them apart.
Ownership Structure and Transfer
While C-Corps establish ownership based on the number of shares issued in exchange for monetary investments, LLCs don’t issue stock and allocate equity shares in percentage pro rata with the owners’ contributions.
As a result, shareholders can easily transfer their ownership rights as they deem necessary by simply selling their shares.
Meanwhile, LLCs are limited in ownership transfer. Unless that aspect is not outlined in detail in an Operating Agreement, ownership transfer will be a tricky task to handle.
C-Corps are about keeping an eye on a number of formal actions and legalities to maintain its compliance status:
Regular meetings are required to make essential decisions and retain control over the business;
Recording procedures are required to keep track of those decisions.
LLCs, on the other hand, have no meeting and record-keeping requirements in place. They just need to file an annual report to stay compliant with the state.
C-Corp taxation methods are straightforward and don’t suggest options. At the same time, C-Corps allow shareholders to save on self-employment taxes and offer capital gains tax optimization.
By way of contrast, LLCs allow for taxation options including C-Corp taxation schemes to catch up with business growth potential and match varying business plans.
C-Corp or LLC? Which is your best alternative? Go for a C-Corp if:
You think big and need a structure to maintain a business with a potential for high profit;
You launch a project that will require investments at some point and you’ll have to source out funds to let it succeed;
You plan an ambitious startup and additional financing programs and fund-raising options won’t go amiss.
Choose an LLC as a legal structure for your enterprise if:
You have a limited budget yet still want the benefits of an independent entity;
You start a smaller private firm with step-by-step growth plans;
You’ve outgrown your disregarded entity and need a legal structure to maintain further business development and protect yourself.
The choice is yours, and we wish you the best of luck!