LLC, C Corp vs S Corp vs Partnership - What's best for you?

Starting a business but can't figure out the best tax structure? Read on and you will find out

LLC (Limited Liability Company)

An LLC is a popular legal structure because it offers personal liability protection, meaning your personal assets (like your home or car) are protected from business debts and lawsuits. LLCs can be taxed in different ways, depending on the owners’ preferences. For example, an LLC can be taxed as a C Corp, S Corp, or a Partnership. This flexibility allows owners to choose the tax structure that best fits their business. So, in a shell, LLC is not even a tax structure and it should not have been mentioned in this blog. It is a "legal wrapper" of your business that prevents you from potential law suites.

C Corporation (C Corp)

A C corporation is taxed as a separate entity, meaning it pays taxes on its earnings directly, rather than passing them through to its owners as an S corporation does. This can be advantageous because the corporate tax rate is currently can be lower (21%) compared to the rates for high-income individuals. Additionally, C corporations can retain more cash for reinvestment in the business, while S corporation owners often need to extract cash to pay for their S Corp taxes on their personal tax returns. C corporations also have the flexibility to issue various classes of stock, including preferred stock, which helps in raising capital. They can have an unlimited number of shareholders, including nonresident aliens and other entities—a feature that S corporations cannot provide. Furthermore, C corporations are beneficial for owners needing extensive fringe benefits and health insurance coverage, which we covered in detail in this blog.

However, a major drawback of the C corporation structure is double taxation. The C corporation is taxed on its income, and shareholders are taxed again when they receive dividends. This issue can be somewhat mitigated if shareholders also serve as employees and pay themselves a salary rather than dividends. By drawing a salary, the owner reduces the C corporation's taxable income (which is subject to a 21% tax rate), but in return, they will have to pay payroll taxes on their salary.

S Corporation (S Corp)

Oh! Our favorite business tax entity! An S Corporation is a special type of corporation that allows income to pass through directly to the shareholders to avoid double taxation. This means that the S Corp itself does not pay federal income taxes. Instead, shareholders report the income on their personal tax returns.

Key points about S Corporations:

• Avoids Double Taxation: The income passes directly to the owners’ personal tax returns, so the corporation itself doesn’t pay income taxes.

• Restrictions on Shareholders: An S Corp can only have up to 100 shareholders, and all shareholders must be U.S. citizens or residents. S Corps also cannot issue multiple classes of stock.

• Reasonable Compensation: S Corps must pay owners a reasonable salary (subject to payroll taxes) if they work for the business. This is in contrast to partnerships, which do not have such requirements.

  
  

Partnership

A partnership is a type of business organization where the owners face unlimited personal liability for the business’s actions(unless it is put in an LLC, or a limited partnership). In partnerships, profits and losses are passed through to the owners, meaning the partnership itself does not pay income taxes (similar to an S corporation). Instead, the partners are responsible for the taxes on their share of the profits and losses according to their personal income tax rates. Unlike S corporations, partnerships do not have a reasonable compensation requirement. Income flowing through partnerships can or can not be subject to self-employment tax, depending on the type of income. For example, many real estate holdings are set up as partnerships because rental income is not subject to self-employment tax, making the self-employment tax avoidance trait of an S corporation unnecessary.

There are no restrictions on the number or types of partners in a general partnership. For instance, an S corporation, a nonresident alien, or another partnership can all be partners. Additionally, you can have more than 100 partners in a partnership. Partnerships also tend to be more flexible with their allocation of income and losses to the partners. In S corporations, however, the allocation of income and losses is fixed and proportionate to the ownership percentage. The other major distinction is the use of debt basis. If the partnership takes on debt, each partner’s basis is increased by their share of the partnership’s debt. This increased basis allows partners to potentially deduct losses or receive distributions without incurring immediate tax liability. This does not happen in an S corporation unless a shareholder directly lends assets to the S corporation.

C Corp vs S Corp vs Partnership vs LLC

• LLC: Not even a tax business entity and we included it in this list just to clear things up.

• C Corp: The business pays its own taxes, and shareholders are taxed again on dividends (double taxation). It’s good for raising capital, issuing multiple classes of stock, and reinvesting earnings into the business.

• S Corp: Avoids double taxation by passing income through to the owners' personal returns, but has restrictions on the number and type of shareholders. S Corps must also pay owners a reasonable salary for their work.

• Partnership: Profits and losses pass through to the owners’ personal tax returns, and there are no restrictions on the number of partners. However, owners are personally liable for the business’s debts and actions, unless the partnership is structured as an LLC.

  
  

  

  
  

Final Thoughts

Choosing the right business structure—whether it's a C Corp, S Corp, or Partnership—depends on factors like liability protection, taxes, and flexibility. Each option has its own pros and cons.

Before making your decision, it’s a good idea to talk to a CPA who can help you understand the specific benefits and challenges of each structure. If you’d like, you can check out our services here. We've helped many business owners navigate the LLC, C Corp vs S Corp vs Partnership dilemma!