DIFFERENCIATION BY EXAMPLES

Limited Liability Company

A Limited Liability Company (LLC) is a business structure allowed by state statute. Each state may use different regulations, you should check with your state if you are interested in starting a Limited Liability Company.

Owners of an LLC are called members. Most states do not restrict ownership, so members may include individuals, corporations, other LLCs and foreign entities. There is no maximum number of members. Most states also permit “single-member” LLCs, those having only one owner.

A few types of businesses generally cannot be LLCs, such as banks and insurance companies. Check your state’s requirements and the federal tax regulations for further information. There are special rules for foreign LLCs.

Classifications

AS PER IRS

Depending on elections made by the LLC and the number of members, the IRS will treat an LLC as either a corporation, partnership, or as part of the LLC’s owner’s tax return (a “disregarded entity”). Specifically, a domestic LLC with at least two members is classified as a partnership for federal income tax purposes unless it files Form 8832 and affirmatively elects to be treated as a corporation. For income tax purposes, an LLC with only one member is treated as an entity disregarded as separate from its owner, unless it files Form 8832 and elects to be treated as a corporation. However, for purposes of employment tax and certain excise taxes, an LLC with only one member is still considered a separate entity.

What’s C-Corp & S-Corp?

The LLC, C-Corp, & S-Corp are business structures that you may choose to be taxed as, depending on owners requirement and Tax Structures implemented. Before looking in-depth difference, You must know that S-Corp is tax structure so business owners could save money on taxes, whereas C-Corp helps business maintain profits within business to re-invest, where C-Corp is more complex and have double taxation.

S-Corporation

S-corporation is not an entity but a tax body which LLC may choose to be taxed as. This tax system was set-up for the small businesses to be taxed without double taxation as C-Corp. So that small businesses could also get similar tax advantages.

To get S-Corp status, you’ll need an LLC or C-Corp registered in the state and apply for S-Corp status in IRS by sending Form 2553. Remember that it’s a Federal Level but not the State Level designation. So the question is whether to tax status you LLC opt when it comes to save money on taxes.

Electing S-Corp Status

Taking an example that Ahmed has a business registered as LLC (Pass-through). The net profit for this business is $100,000 after all the expenses being deducted. Isn’t that a great chunk? But wait, Ahmed has to deduct 15.3% of self-employment tax (NOTE THAT SELF-EMPLOYMENT TAX AND INCOME TAX ARE NOT SAME)which is $15,300.

So being an LLC (Pass-through entity) Ahmed will be paying $15,300 tax bill on $100,000 net profit.

What if Ahmed elects his LLC as S-Corp Status? Financial scenario will not be the same. S-Corp can lower your tax bill because of the dividend nature. Under S-Corp the owner designate him-self as an employee like Managing Company in IRS and gets dividend (salary) for that position. A reasonable salary is paid by the business to the owner which is called dividend.

Coming back, Ahmed under S-Corp is a Manager, paying himself average market salary of $40000. Taking out the dividend from the $100,000 of LLC profit is now $60,000. The 15.3% of $60,000 is $9,180. Hence Ahmed is now paying the tax bill of $9,180 and saving $6,120 being S-Corp which is approximately 40% of self-employment tax saving.

So if Ahmed’s LLC profits were $40,000 what’d be the scenario?

S-Corp is opt to save self-employment tax of 15.3%. If he’s earnings were as much or less than what he could earn as an employee in other firms, than there’s no need to opt such status for LLC as he can’t save money on taxes

Designating business as S-Corp, as compared to an LLC has more legal works and documentations. You’ll need you r payroll slip every month and pay self-employment taxes. You’ll need to add Schedule-K-1s in your business tax returns.

What we Learnt?

Pros of being LLC
. Assets are Protected (Due to Limited Liability)
. Unlimited Members
. Less Paperwork

Pros of being LLC
. All Net Profits are taxed
. Doesn’t allow to re-invest profits to the business
. LLC dissolves if a member leaves

C-Corporation

If you have reached this segment you’re probably acknowledge the facts between LLC and S-Corp. You might be thinking that C-Corp has double taxation why would anyone opt C-Corp for their business?

C-Corp also helps business to save taxes but via different route, As you read before that in LLC or S-Corp profits are paid out. But with a C-Corp those profits can stay within business.

As previous example the profit for Ahmed’s business was $100,000. if he pays himself $75,000 and keep the $25,000 within the business as retained earnings (such earnings which are held in the business for business growth are called retained earnings.).

Remember increase in retained earnings increases net worth of the business. For example Meta (Facebook) had $86 Billion in 2020 as net worth while it retained earnings and made $117.9 billion in 2021 of net worth.

Company is forced to be C-Corporation if its requirements are:
. Over 100 Shareholders
. Foreign Shareholders
. Partnership or another corporation as shareholder
. Multiple classes of stock
. Certain institution ( Insurance and Financial Companies)

What we Learnt?

Pros of being C-Corp
. Assets are Protected (Due to Limited Liability)
. Unlimited Shareholders
. Existence without original owner
. Investors friendly
. Keeping profits in business without being taxed

Cons of being C-Corp
. Double Taxation ( Corporate Tax and Individual Tax )
. Yearly Board of Directors Meeting
. Complex Accounting (Requiring Assistance of CPA)