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One of the most important considerations when starting a business is whether to create an LLC or a C-Corp. Either option has far-reaching implications on nearly every aspect of your business. So it is necessary to understand what each option has to offer, and the potential drawbacks.
Why Understanding The Difference Between an LLC and a C-Corp Is So Important
You may be in a rush to set up your business structure. But, it is important to weigh your options carefully before pulling the trigger. Usually, this means choosing between an LLC and a C-Corp.
First, both LLC and C-Corp come with a significant advantage. In both instances, owners, members, shareholders, and investors enjoy limited liability protection. Limited liability is a form of legal protection that separates business assets and finances from personal assets and finances. This level of protection isn’t advanced to sole proprietorships and partnerships.
In the case of LLCs and C-Corps, the business is legally classified as a person. Therefore, the business is responsible for its own liabilities, debts, and financial losses. This means your personal finances will be protected in case the business fails or is sued.
However, this is where the similarities between LLCs and C-Corps end. Therefore, choosing either option has immediate and long-term implications for your business. We’ll explore the practical and business implications of LLCs vs. C-Corps in the next sections.
For now, the business entity you choose will have implications in:
- Stock Options
There’s also another business entity known as an S-Corp. An S-Corp is simply a C-Corp that has elected to receive special tax status with the IRS.
Quick Tips To Help You Choose Between LLC and C-Corp Today
Now we get to the heart of the matter of LLCs vs. C-Corps. First, what’s the difference between the two entities? Then, more importantly, which one should you set up?
As luck would have it, you can compare several elements to help you understand the differences between the two entities. You’ll also be able to choose the one that makes the most sense for your purposes.
Which One Is Easier To Form?
If you want to set up your business right away, the formation process is different for an LLC vs. a C-Corp.
The specific requirements for forming either type of entity vary from state to state. But setting up an LLC is generally more straightforward. You’ll need to file an Article of Organizations with the secretary of state and draw up an operating agreement.
The process of forming a C-Corp is more drawn-out. Besides filing an Article of Incorporation with the secretary of state, you’ll also need to:
- Establish and maintain a board of directors
- Comply with federal and state shareholder and stock laws
- Have at least two officers, including a president and a secretary
- Hold annual shareholder meetings
- Keep corporate minutes of shareholder meetings
- File annual reports
While many of these requirements are also recommended for LLC, they aren’t mandated by law. Moreover, for most small businesses just starting, forming a C-Corp may be too time-consuming and expensive.
Which One’s More Flexible?
LLC’s tend to be more flexible, while C-Corps are more rigid. However, if you still aren’t sure of your ownership and management structure, an LLC may be worth looking into. You’ll have the freedom to oversee day-to-day operations or appoint one of the owners to take up this role. It’s also much easier to split duties and hire an external manager if you wish.
Things are far more rigid with a C-Corp. For example, you’ll need to hire a board of directors. The board will be in charge of setting and overseeing business goals. This structure can make it challenging to exercise autonomy as an owner since you have to consult with the board of directors before making decisions or implementing organizational changes.
Setup and Annual Costs of an LLC vs. a C-Corp
Again, the exact cost of setting up and maintaining an LLC vs. a Corporation varies by state. So, the cost of setting up and running either business structure varies by state.
Both business entities attract a filing fee. In Delaware, for example, the filing fee is $110 for LLCs and $109 for Corporations. In Nebraska, on the other hand, you pay a $109 filing fee for an LLC and $68 for a C-Corp. So, the initial setup cost for either entity depends on your location.
Most states also charge annual fees, often known as the Annual Report. Once more, this fee varies by state. It is worth comparing these fees before deciding on your business entity. For example, you may find that setting up a Corporation is cheaper than an LLC, as is the case in Delaware.
Consider The Tax Implications
One of the obvious differences between an LLC and a C-Corp comes at tax time. LLCs, enjoy what is known as ‘pass-through’ taxation. Under this type of taxation, business profits and losses pass through to the LLC members. The IRS doesn’t apply a corporate tax code. Instead, members report business profits in their personal tax returns. This means that the profits are only taxed at the individual level.
On the flip side, C-Corps face double taxation. Here, the IRS collects taxes on the company’s profits at the corporate level. Then, shareholders pay tax at the individual level when the profits are distributed as dividends.
C-Corps can bypass this problem by filing Form 2253 to create an S-Corp. In this case, the S-Corp enjoys the pass-through benefits of the LLC.
However, S-Corps are limited to 100 shareholders, so converting a C-Corp to an S-Corp is not always possible. The S-Corp designation also restricts shareholders to U.S. citizens and residents and only allows you to offer one class of stock. So, the tax advantages of the S-Corp come with some tradeoffs.
Any Plans for Venture Capital or Angel Investors?
LLCs have severe limitations if you plan on raising funds from angel investors or venture capitalists. For one, LLCs don’t have shareholders or stocks. Instead, the Operating Agreement determines the financial rights of all members. These rights may be based on membership units or percentages. This process can be cumbersome, causing many investors to prefer funding C-Corps over LLCs.
S-Corps also have similar limitations. For example, all shareholders must be US citizens or residents. This limitation rules out the possibility of foreign investment. Additionally, you’ll only be able to issue one kind of stock. Again, this restriction can severely limit your investment potential. Finally, your shareholders will be limited to 100.
So, if you plan to go public in the future or raise funds from investors, your best bet may be a C-Corp. It is easy to distribute dividends to shareholders in a Corporation. Additionally, shareholders have the option to hold on to their stock or sell it off.
Get A Professional Opinion
If all else fails and you can’t decide on the appropriate business structure, a business attorney can help clear things up. You don’t even have to contact a lawyer to get an expert opinion on the matter. LegalZoom, an online legal service, can help settle the issue once and for all.
Simply go to this page and fill out the requested information. You’ll be asked to provide a few details, including:
- Where your business will be operating
- Whether it’s for-profit or non-profit
- If you’re the sole owner
- If you’d like to bring in an investor
- If you plan to change your decision changing structure
- Whether you’ll be offering a professional service
Then, provide your email address, and LegalZoom will send you the results of the questionnaire. This service is free and only takes a few minutes to complete.
Whether you end up choosing an LLC or C-Corp, you can use LegalZoom to create your business entity. The charges start at $79 plus state filing fees for an LLC and $149 plus state filing fees for a C-Corp. In addition, you won’t have to worry about the insipid details of the formation process, including verifying your business name availability, preparing an Articles of Incorporation or Articles of Organization, and following up with the secretary of state.
Long-Term Strategies for Choosing Between an LLC and a C-Corp
Some considerations when choosing between LLC and C-Corp require a long-term view of your business. This approach will help you make the right decision from the get-go. You can potentially save time and money associated with converting an LLC to a C-Corp by choosing the correct structure, to begin with.
Might You Want To Sell Your Business in the Future?
Another crucial long-term consideration when choosing between an LLC and C-Corp is whether you’d wish to sell your business. For one, selling a C-Corp in exchange for stocks is much easier under the IRC section 386. You can also reorganize your business much easier if it’s a corporation.
So, if you hope to sell your business in the future, a corporation is the better option. In addition, you’ll be able to avoid expensive tax reorganizations this way.
Potential Duration of the Company
A C-Corp is a more favorable option if you plan to build an enduring business. Certain scenarios can cause the dissolution of an LLC, including if a member dies, leaves the business, or declares bankruptcy. In this case, the remaining members will need to create a new LLC from scratch. It is always possible to include details of what happens when a member leaves or dies in the LLC’s operating agreement. But, the dissolution of the business is still an ever-present threat in these scenarios.
On the other hand, a corporation can have perpetual life. This longevity can be built into the company’s bylaws. In this case, the business can continue to exist when a significant shareholder dies or leaves the company. It is also easier to transfer the leaving shareholder’s ownership shares. The remaining shareholders can transfer share ownership by selling or bequeathing them to someone else. Generally, these shares are passed on to the shareholders’ heir in the event of their death.
Retaining Intellectual Property
Protecting intellectual property is a crucial consideration for many startups, especially in the technology field. Ideally, you’d want the business to own the intellectual property. C-Corps are perfect in this scenario because the company still owns the IP if a founding member leaves the organization.
Another advantage of this setup is a founding member cannot hold the business hostage over IP rights. Unfortunately, this scenario is relatively common when disputes between co-founders arise. Additionally, a C-Corp offers transparency as far as member’s contributions are concerned.
Finally, intellectual property can be considered part of the business’ assets. This can increase the business’ value and make it more attractive to investors. However, intellectual property rights issues are much harder to negotiate with single-member LLCs.
The next step is to apply for the necessary licenses and permits you need to operate your business. These requirements vary on the federal and state level and depending on the industry you’ll be operating in. It is worth paying for professional advice, just to make sure you don’t miss anything. This is especially true for specialized industries that are notoriously difficult to navigate. The Small Business Administration website offers a great resource to help you understand typical business licenses and permits.
Finally, you’ll need to file the necessary paperwork with the secretary of state. The specific documents you need to file depend on your preferred business structure and your state. Again, you can work with an attorney to make sure you file the correct papers. Alternatively, an online legal service like LegalZoom can take over the entire process. This option is attractive if you’d like to be completely hands-off in the formation process and minimize errors that may draw out the process.
Here are three more Crazy Egg guide to help you with the formation process: