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Your business structure will determine how easily you can raise external funding, how much you pay in taxes, and even the possibility of finding partners and employees to support your growth.
From the get-go, it is important to select a business entity type that aligns with your business’s current and future goals, even if your anticipated growth is years away. For many entrepreneurs, this decision means choosing between registering their business as a C corp or an LLC.
Early-stage entrepreneurs need to weigh the pros and cons of each business structure while also considering their associated tax liability.
This article will help you fully understand the key differences between C corps and LLCs and explore the advantages (and disadvantages) of operating under each business structure.
What is a C corp?
A C corporation is a business structure where your business is recognized as a distinct entity separate from you and your other shareholders. As such, the corporation is taxed separately from the owners, who are still required to pay personal income tax on their earnings from the corporation.
This separate tax is known as “double taxation,” and it’s a unique feature of C corps.
C corps are also required to have a board of directors, voted in by the shareholders. This board, along with the shareholders, is required to hold at least one meeting per year.
Registering your business as a C corp protects your personal assets from any company liability since the business is now an entity of its own. If the business fails, this ensures you only lose what you have invested in the business.
There are several steps required to form a C corp. You’ll need to do the following:
- Decide on a business name
- Choose the state you want to register in (Delaware is one of the most popular states for incorporation in the US, for several reasons)
- Form your new business under your chosen name
- File the articles of organization in the state the business will be operating from
- Pay any required state fees
You will also need to obtain an employer identification number from the IRS so you can set up a bank account and file your taxes when required.
Helpful resource: Is Incorporating Right For You? A Starter’s Guide
Advantages of registering as a C corp
When you register your business as a C corp, you’ll be able to:
- Protect your personal assets (i.e., liability protection)
- Access large capital through share offers
- Make better decisions due to proper corporate governance
- Enjoy fringe benefits, profit reinvestment, and other corporate tax benefits
Liability protection means you and your fellow shareholders/owners won’t lose any of your personal assets if the business incurs large debts or has to shut down.
The C corporation’s structure protects you from personal liability because it requires that business debts be repaid using only what you and other shareholders have invested in the business.
Access to large capital
As a C corp, your business can issue share offers to the public and have people buy into the business. This is a great way to raise capital for business expansion or even allow for new experiments at the company.
Proper corporate governance
Well-run companies usually benefit from a clearly defined structure that can keep a business running smoothly and ensure the best decisions are being made. C corps must have a board of directors and hold regular meetings, which means greater accountability and structure.
With a board of directors, all shareholder and employee activities and company processes are more closely monitored. In addition, the company’s bylaws help ensure everyone follows due process.
Investors also tend to prefer to invest in well-structured businesses, which means C corps enjoy easier access to venture capital.
Corporate tax benefits
Every C corp is required to pay the IRS a corporate tax on its profit. If your C corp members decide to reinvest the profits made, you can do so at a lower corporate tax rate.
And unlike individual tax returns, corporate tax returns also allow you to deduct medical insurance, retirement plan payments, and other employee benefits.
Disadvantages of a C corp
Of course, there are also disadvantages to registering your business as a C corp. These include:
- Double taxation
- Lengthy and expensive setup process
- Rigidity of operations
Every time a C corp makes a profit, it pays a corporate tax on its business income, then pays out dividends to shareholders who again pay taxes on these dividends. This means a C corp pays taxes twice on the same income—first as corporate tax, then as income tax through its shareholders.
Lengthy setup process
If you register your business as a C corp, you have to deal with a lot of paperwork. This includes filing Form SS-4, creating company bylaws, submitting board of director details, and much more. Not only does this setup take time, but it also costs money.
Rigidity of operations
Running a C corp means following many strict guidelines, which can quickly hamper growth and cause major headaches. For instance, certain decisions—such as corporate-level appointments—can only be made by the board of directors.
Other C corp expectations, like required bylaws, annual shareholder meetings, and voting, can reduce your business-making flexibility, given the time needed to allow for these processes.
What is an LLC?
A Limited Liability Company (LLC) can be considered a hybrid business structure since it combines the features of a corporation with those of a sole proprietorship or partnership.
Registering your business as an LLC gives you and other members of the business protection from losing your personal assets due to company liability. This is because LLCs, like C corps, are recognized as separate entities under the law.
When it comes to filing tax returns for an LLC, entrepreneurs enjoy pass-through taxation. This means the business itself doesn’t pay any direct tax on the profits made. Rather, the tax is “passed through” to each member of the LLC, who then pay an individual tax based on the percentage of the company profit they received.
As a result, LLCs don’t pay corporate tax. Instead, LLC owners pay an income tax based on their earnings and income tax rate. This is possible because an LLC can be treated as a partnership for tax purposes.
It’s also very easy to register your business as an LLC. The legal requirements are simple: you and your co-owners just decide on a name, register that name, file the articles of organization in the state the business will be operating from, and pay the required fees.
Once this is done, the business becomes a legal entity with an employer identification number. Unlike C corporations, LLCs are not obligated to have a board of directors or meet regularly.
Advantages of registering as an LLC
Because LLCs are a hybrid of other business structures, their advantages can be compelling. They include:
- Limited liability protection
- Ease of setup
- Pass-through taxation
- Fewer corporate formalities
Limited liability protection
Just like a C corp, an LLC protects the assets of its owners from being lost to business debts. This is because the business entity is recognized as separate from its owners with its own distinct assets.
Ease of setup
Unlike C corps, LLCs require fewer fees and paperwork. To incorporate as an LLC, the business simply has to file articles of organization and pay a registration fee. This fee is fixed by the Secretary of State’s office in the state where the LLC is being registered.
This simpler process means that LLCs can be registered faster than C corps, as requirements like bylaws and board of director setup aren’t needed.
Pass-through taxation is perhaps most obvious advantage of structuring your business as an LLC. When the business isn’t a taxable entity in the eyes of the IRS, only its members are taxed on their income from the business, not the business itself.
Owners of an LLC can also enjoy pass-through deductions. If their taxable income falls under a certain amount, they could qualify for a 20% deduction which wouldn’t be subject to tax.
Fewer corporate formalities
An LLC’s operations can be much simpler than a C corp’s. With its more flexible management structure, LLC owners can make business decisions themselves instead of waiting for approval from a board of directors. Some states allow the registration of single-member LLCs, which means you can make all business decisions, just like a sole proprietor.
Even with profit-sharing and the addition of new members, existing members of the LLC can agree among themselves to carry out whichever actions they deem right for the business without having to hold a formal meeting with a board of directors. This often makes operations faster.
LLCs are also allowed to use the simpler method of cash basis accounting instead of being required to follow accrual basis accounting. Annual reports and other detailed financial reports may not be obligatory, either.
Disadvantages of an LLC
Despite the tax advantages of an LLC, this hybrid business structure does have some disadvantages. These include:
- Difficulty of transferring ownership
- Fewer ways to raise capital
- Fewer fringe benefits and possibly more taxes
Transfer of ownership
One of the biggest challenges of running an LLC is the difficulty of transferring ownership. While a C corp allows owners to sell off their shares, LLCs require an operating agreement from existing members in order to add new members or change ownership structures.
If a member dies or abruptly withdraws from an LLC, the business entity could face dissolution unless proper succession plans are outlined in the LLC’s agreement. An LLC can also be dissolved because of late tax filing or failing to file taxes at all.
Difficulty raising capital
Because LLCs can’t sell shares to the public to help expand and grow the company, it can be difficult to raise more capital when needed. Most LLCs raise cash by having their existing members invest more money or find new members to join the LLC.
If you’re trying to scale, registering your business as an LLC could make this more difficult.
Fewer fringe benefits
Given the taxation structure of LLCs, employees might get fewer fringe benefits like medical insurance as these benefits are sometimes treated as part of their taxable income.
You might also end up paying more taxes as an LLC owner, thanks to the self-employment tax imposed on LLCs. This tax consists of a 12.4% Social Security tax and a 2.9% Medicare tax.
LLC regulations can also vary by state, making it difficult to manage if you have businesses across different states.
Which business structure is better for you?
As an early-stage entrepreneur, you should start by prioritizing your long-term business goals. Do you want to scale rapidly, for example, or jump through fewer regulatory hoops? Once you know where you’re headed, you can choose the business structure that will get you closest to achieving your goals.
Although C corps and LLCs have certain similarities, their unique features offer very different benefits for your business. Understanding how those distinct features can work for you will help you make the right choice.
How Bench can help
Need help deciding on the best entity type for your business? You don’t have to do it alone. Download our free business entity guide where we’ll walk you through the key differences between an LLC, S corporation, and C corporation.
If you’re ready to move forward with incorporation, get in touch with our team to connect with our trusted incorporation partner who can help you file the necessary paperwork for your business.
Have complex questions that we can’t answer immediately? Our network of experts will help us find the answer for you, and we’ll follow up with an explanation as quickly as possible.