C Corp vs. LLC: What's the Difference?
C Corp vs. LLC: What's the Difference?
Understanding what business structure to select for your small business can have significant impacts on your business’ future. The legal structure you choose can impact how you file taxes, your tax obligations, your financial planning, and what your personal liability and protections will be.
This guide will take you through a quick overview of corporate entity types and liability, the differences between C corp vs LLC, and how to choose the best structure for your business.
Most business owners debate between two primary options: a corporation (C corp) or a limited liability company (LLC).
What Are Corporate Entities?
Corporate entities are legally registered business structures formed to provide business owners (and, in some cases, shareholders) with certain legal and financial privileges according to federal, state, and local laws.
The main types of corporate entities are:
- Sole Proprietorship
- Limited Liability Partnership
- C Corporation (C corp)
- S Corporation (S corp)
- Limited Liability Company (LLC)
While you could look up a definition of each of these and attempt to parse through the legalese that describes them, the best way to understand corporate structures (and what sets them apart) is to grasp one key concept: liability.
Unpacking Liability: An Introduction
You may have noticed that the word “liability” appears in two of the terms listed above. However, liability is relevant to all these legal entities. So, what is it exactly?
According to Investopedia:
“A liability is something a person or company owes, usually a sum of money. Liabilities are settled over time through the transfer of economic benefits including money, goods, or services...liabilities include loans, accounts payable, mortgages, deferred revenues, bonds, warranties, and accrued expenses.”
When it comes to businesses, the critical term here is “accrued expenses.” When you take on your company’s liability, you also take on its expenses—importantly, its financial debts.
This is precisely why corporate entities exist—to protect your individual assets from the burden of business liability. Or, more precisely, to determine how much of that burden you are willing to shoulder. The extent to which your individual assets are protected is one of the main factors that sets each business entity apart—and one of the most important considerations you should be making when deciding on your company structure.
Additionally, there’s also the matter of legal liability, wherein the owner is held responsible for damages incurred to another party. Some entities help protect the business owner from being held liable for the actions of the company.
Liability and Corporate “Distance”
Liability implies a certain amount of “distance” between a business and its owners. For example, in a sole proprietorship, that distance is relatively small—legally, the individual and the business are one and the same, meaning founders are fully liable for any debts accrued by the business.
As this distance widens, a business owner’s liability decreases.
LLCs and C corps are legally distinct from their owners. And although the extent to which they are separate from their founders differs, it is this distance that leads to their key similarity: limited liability protection.
C Corps and LLCs: Limited Liability Protection and Other Similarities
Both LLCs and C corps offer founders (and shareholders, in the case of C corps) limited liability, meaning the extent of their economic loss is capped at the amount they invested in the venture. This protects their personal assets if the company goes bankrupt or racks up debt, as well as protecting owners legally if the company were to face a lawsuit.
In other words, limited liability protection limits a business owner’s financial losses and legal liability.
This key detail is what draws new business owners to these two corporate structures. While liability is the key differentiating factor between the two, there are other practical and operational differences.
C Corp vs LLC: Additional Differences
There are four main areas where C corps and LLCs differ, all of which you should take into account before deciding on the ideal one for your business:
- Ownership, assets, and equity
- Tax forms and filing
- Ability to raise funds
- Operational costs and red tape
#1 Ownership, Assets, and Equity
The relationship between owners and employees, as defined by a business structure, can make certain operations far easier, especially for companies with international interests. Here are some of the ways in which matters of ownership and equity are affected by your corporate entity:
- Equity – C corps are considered their own legal business entity. As a result, many parties can own a piece of the company (i.e. an equity stake). Equity simply represents the total amount of money that would be returned to the company’s shareholders should all of the liquid and illiquid assets be sold and company debts paid off. Or, if it’s acquired, it’s the value of the company minus the sale of any liabilities
- Vesting – Vesting is the process of offering ownership to employees over time through the gradual transferring of company equity. This process is far simpler in a corporation, where there is a clear delineation between partners, owners, and employees.
- Employee Ownership – Corporations offer far more rigid protocols for doling out equity or options for equity to employees. For an LLC owner, however, becoming a member is a bit less appealing due to potential tax complications.
- International Ownership – Because an LLC owner is taxed directly instead of the entity, international ownership makes tax reporting quite tricky. For example, a non-US citizen co-owning an LLC may be taxed on their income both through the US and their home country. With corporations, this type of ownership is far simpler for tax purposes.
- Lifespan – Depending on the state, LLCs have a dissolution date, making transferal of power to new owners difficult. C corps, however, have perpetual life and can be more easily transitioned to new owners.
- Assets and IP – LLCs are excellent structures for side projects or bootstrapped businesses. Why? Because, unlike in a C corp, IP and money are more easily transferred between an LLC and its members, with minimal tax implications.
#2 Tax Forms and Filing
Taxation is one of the most significant differences between these two business structures. By default, LLCs and C corps are taxed as follows:
- LLCs – LLC owners are only expected to file a form called a Schedule C alongside a 1040 (the same form filed by sole proprietorships), which is simply attached to their individual tax return. This means that when calculating quarterly taxes, they will be “passed-through” to owners, meaning they are only taxed once. Furthermore, deductions, credits, and losses can potentially offset personal income on individual tax returns, making LLCs an attractive corporate structure from a tax perspective.
- C corps – Corporations, on the other hand, are expected to file a C Corporation Form 1120. On top of that, shareholders are expected to pay a dividend tax, and business owners must pay a business income tax. As Business Insider notes, “C Corps are taxed at the corporate level, so any income that flows through to owners and investors in the company will essentially get taxed twice.” This “double taxation” can dissuade founders from registering their company as a corporation.
#3 Ability to Raise Funds
The flexibility of an LLC can sometimes backfire when trying to raise funds from venture capitalists and angel investors. C corps makes this process easier and can operate internationally with fewer hiccups.
C corporations offer the rigidity and standardization that makes investing more straightforward and less expensive. They can issue separate stock classes, which makes it possible to set various protections, valuations, or preference levels compared with normal stockholders. On the flip side, LLCs typically require a complicated operating agreement to secure funding, not to mention they lack the tax-exemption status that venture fund investors prefer. This difference is so significant that some investors may even expect an LLC to convert to a C corp before they take any financial risks.
This factor is especially important when the business has an exit strategy or intends to scale quickly.
#4 Operational Costs and Red Tape
The paperwork required to establish an LLC and C corp—and keep them operational—may differ. As a consequence, costs for accounting and legal assistance also tend to differ.
C corps are known to be the most complex and expensive entity to establish and then operate due to the immense liability protection they afford owners. That’s in addition to their independence from founders and shareholders. These legal and financial privileges naturally lead to stricter tax requirements and regulations that may dissuade business owners from adopting a C corp business structure.
How Do You Choose Between a C Corp and an LLC?
With so many factors to consider, let’s recap some of the main draws to each business structure.
Pros of an LLC structure:
- No “double taxation”
- Generally less costly to form
- Often preferred for side projects or bootstrapped businesses
- Offers some liability protection
Pros of a C corp:
- Perpetual life
- Raising funds is easier
- Best for going public and operating internationally
- More attractive to international and professional investors
- Offers limited liability protection
Ultimately, it’s up to you and your partners to assess your company and determine whether a C corp or LLC is right for your business.
Converting Your LLC to a C Corp
Fortunately, if you choose to start as an LLC, it’s possible (or even advisable) to convert to a corporation down the road. Many LLCs experience significant growth and eventually transition into a C corp. Here are just a few reasons you may choose to make the switch:
- To raise funds more easily by attracting a wider swath of investors
- If you want to sell public stock offerings
- If you are interested in compensating certain personnel with stock
- To transfer ownership more easily
Fortunately, this is possible. Depending on the state you’re operating in, you can likely undergo three types of conversions:
- Statutory conversion
- Statutory merger
- Non-statutory conversion
While a statutory conversion is the simplest and most ideal process (because it streamlines the conversion into a rather simple transfer of forms), it is not available universally. To learn more about the conversion options available to you in your state, consult with a professional familiar with your business.
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