LLC vs S-Corp vs C-Corp: Tax Differences Explained

A business structure directly affects your long-term business goals and return on investment. Even if you are a good business owner, choosing the wrong business structure may cause you to pay more tax. If you have basic knowledge of LLCs, S corps, and C corps and want to expand your business, then you are in the right place. In this write-up, we are going to discuss LLC vs S-corp vs C-corp and explain which one may be best for you to help save the most taxes.

Understanding LLC, S Corp, and C Corp Business Structures

LLC, S Corp, and C Corp are business structures that help protect personal assets and manage income. However, each structure works differently. LLC is a business structure that protects your assets and keeps your personal savings, home, and other assets safe even when you have debt.

An S Corp is a tax status designed for businesses that don’t pay tax directly; instead, they pass profits and losses through. It’s ideal for businesses that want to save payroll taxes. They help business owners save on self-employment taxes through pass-through taxation.

A C Corp is a business structure separate from its owners with limited liability and unlimited investors. These types of businesses pay double taxes. The corporation pays income tax on its profits, and owners pay personal income tax on dividends. Hence, it involves double taxation.

How LLC Is Taxed

The tax process of an LLC is flexible. There isn’t a single way an LLC is taxed. It depends on whether it is a single-member or multi-member LLC. Overall, the IRS taxes the LLC based on who owns it. Here is a clear explanation.

Single-member LLC

It’s treated as a sole proprietorship entity. It’s taxed based on the owner’s personal tax return. Profits are taxed, and personal assets, such as a home and savings, are protected from business debts and losses.

Multi-Member LLC

If the LLC is owned by two or more owners, then it gets partnership flexibility. It means the tax is distributed equally among the members, and the profits and losses are passed through. It doesn’t involve double taxation, and members pay self-employment tax on their earnings.

How S Corporation Is Taxed

An S corporation is taxed on business losses, profits, and credits, which pass through to the shareholders, who report them on their personal tax returns. S corporations do not pay federal income tax at the business level, which helps avoid double taxation. The profits are taxed at individual rates, not at the corporate level. Overall, the tax is paid by the owners, not the business. Owners pay tax according to their ownership percentage. The owner’s individual share is reported on Schedule K-1.

How C Corporation Is Taxed

C corporation is separate from its owners with its own income and tax rules. It pays federal income tax on its profits, and the owners or shareholders pay tax on their earnings. Hence, it involves double taxation. However, these corporations can deduct business expenses, salaries, and advertising.

If shareholders work for the company, they can receive salaries, which are treated as monthly wages and a business expense. This way, C corporations reduce the taxable income. Moreover, the dividends are taxed to shareholders depending on their personal tax returns. As dividends are not a business expense, the company can’t deduct them.

LLC vs S Corp vs C Corp: Tax Differences

All three business types have different tax procedures. An LLC company follows pass-through taxation, where profits directly go to the owners or shareholders. Then, the owners pay personal income tax. S corporations also follow pass-through taxation, and owners pay the personal income tax. C corporations are separate from their owners, and they pay corporate tax, and their owners pay tax on dividends. Here is the clear difference between all three business structures.

Which Business Structure Pays Less Tax

There is no business structure that pays less tax; however, it depends on the overall profit a business makes and the owner’s income. LLCs and S corporations save corporate tax by passing through profits directly to the owners. Hence, they have to pay self-employment tax on all profits. On the other hand, C corporations pay corporate taxes, and owners pay personal income tax on dividends. However, these taxes might be lower than given on high profits in the pass-through businesses.

Overall, S corporations pay less tax when their profits are steady, and the owner receives a salary. The owner can show salary as a business expense, which ultimately leads to low tax rates. Plus, it doesn’t pay federal income tax at the business level.

Which Is Better for Taxes: LLC or S Corp

It depends on the business goals, income level, and profits generated. Typically, an LLC is a simple and flexible business structure where profits and credits are passed through to the owners. They pay tax on their personal incomes. On the other hand, an S Corp is a business status where the owner receives a reasonable salary and shows it as a business expense to save money on self-employment tax.

It’s a better option if the profits are good, and paying on profits will cost more. Therefore, an LLC is a better choice for small businesses that make a modest profit, and the owners can pay self-employment taxes. An S corporation is the best fit if a business makes a high profit and wants to save thousands of dollars on taxes.

Best Business Structure for Taxes

A business structure that aligns with your long-term business goals is the best one for taxes. It should be profitable in the long run. For instance, an LLC business is best for small businesses, solo entrepreneurs, and real estate investors who want a simple and convenient option for taxation. They simply have to pay self-employment taxes on all profits with fewer formalities.

An S corporation is an ideal choice for profitable businesses that want long-term growth and low self-employment tax. Owners can take their salaries, showcasing them as a business expense, which leads to a heavy tax reduction if the profits are steady. It is perfect to cut the self-employment tax.

A C corporation is the best fit for startups wanting growth and a place in the saturated marketplace. There is a separate entity that pays corporate tax, and shareholders pay tax on the dividends they receive. It involves double taxation; however, this tax rate may be lower for businesses with very high profits. And the best part about C corporations is that they can keep unlimited shareholders in the business, which shares the tax burden and opens opportunities for capital growth.

Common Tax Mistakes When Choosing a Business Structure

Choosing a business structure can be confusing, and mistakes may reduce profits over time. Below are the most common mistakes people make.

Wrong Business Structure

Choosing a business structure that doesn’t align with the business income, growth plans, and profit and liability protection. As a result, they may pay more tax. Hence, businesses should consult a professional before making a choice.

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Poor Income Records

Businesses that don’t have a clear track record of income, expenses, taxes, and profits may make mistakes when it comes to choosing the right business structure. Hence, businesses should hire professional bookkeepers to keep a record of all expenses and deductions.

Mixing Personal and Business Expenses

Generally, small business owners mix up personal and business expenses, which blurs the business deductions, taxes, and income. Therefore, bank accounts for personal and business expenses should be maintained separately.