Engaging in a new business venture is daunting, and it involves many key decisions. One of the main decisions you will have to make is to select the type of corporation for your business. If you do not carefully select the type of your business, your business will either be treated as a sole proprietorship (single owner) or as a general partnership (multiple owners). A benefit of forming a solo proprietorship or a general partnership is that they are the easiest entities to form; however, they have a critical flaw – they do not provide a separation between the business entity and its owners.

General partnerships do not protect you if your business is sued or if its bills are not paid. The creditors can after your personal assets. This is the main reason why C-corporation, corporation, or Limited Liability Companies (LLC) are selected because they protect the owners from personal liability. It is important to keep in mind that each of the three above corporations have a vastly different tax implications.

Here, we will explain some of the key tax differences, but you should always consult with your CPA or your attorney to meet the unique needs of your business venture.

A. Deducting losses.

LLC members who actively work in the business are able to deduct the business’s operating losses on their personal tax return to offset other income. C corporation shareholders are not able to deduct these losses but S corporation shareholders can. 

One of the advantages of LLC’s and S-corporations is that active members of an LLC or a shareholder of a S-Corp. may deducts the business’s operating losses from their personal tax returns. On the other hand, C-corp. shareholder are not given these benefits.

B. Social security and Medicare taxes.

LLC members are not considered employees, so their share of the profit is not subject to social security or Medicare tax. However, LLC members who actively work in the business need to pay self-employment taxes on their income (including salary and their share of any profits). However, with a corporation, only the salaries are subject to social security and Medicare taxes. Any profit distribution isn’t subject to these taxes.  

A key benefit of a corporation is that its shareholders only need to account for their salaries for social security and Medicare taxes. Profits distributed to shareholders from corporations are not subject social security and Medicare taxes. In regards to the members of LLC’s that are actively working for the business, they must pay self-employment taxes, which include their salary and share of any profits. However, LLC members’ share of profits are also not subject to social security and Medicare taxes because they are not considered as employees of the corporation.

It is important to note that LLC’s can choose to be taxed as a corporation. Under that scenario, only the member’s salary will be considered for social security and Medicare taxes, and their profit share will be exempt.

C. Investing profits back into the company.

C-corps. are subject double-taxes. However, they offer more flexibility in shifting income in comparison to LCC’s and S-corps. For example, members of LLCs must pay for their share of profits regardless of whether their profits stayed in the business or were put into their individual accounts.

Owners of C-corps. are instead taxed only on the dividend they take home. If you find the right tax-consultant, you can take advantage of lower income tax brackets. If your company made $100,000 in profits past year, for example, you can leave $70,000 in your corporation and be taxed only on $30,000 you take home as your salary.

D. Double-taxes.

By default, LLCs are considered “pass-through” companies, which are treated similarly to a sole proprietorship or partnership. The LLC itself doesn’t pay income taxes on profits. Instead profits or loss are “passed through” to the members and reported on their personal tax returns. 

In contrast, because a corporation is considered a separate legal entity, they have to file separate returns and pay income taxes on its profits. In certain circumstances, this can lead to “double taxation," meaning the corporation pays for taxes on their profits and their shareholders have to pay taxes on their dividends. Double-taxes can become very costly.  

Remember that a corp. may choose to be treated as a pass-through entity like an LLC, and an LLC may elect to be taxes as a s-corp. 

E. Employee benefits

LLCs and corps offer some key differences when it comes to employee benefits. For examples, stock options and certain retirement plans are available for C-corps. Furthermore, S-corps shareholders with more than two-percent shares and LLC members are required to pay taxes for some employee benefits such as health benefits, HASs, FSAs, and insurance. C-corp. shareholders are not subject to these taxes.

There is no one type of business structure that is right for all businesses. You must do your research, consult with a qualified expert to meet the needs of your unique venture.