October 15, 2020 By SmartBiz Team

As a business owner, you can classify your company with the IRS in one of four ways: as a sole proprietorship, a partnership, an S corporation, or a C corporation. If you own a limited liability company (LLC), you might be wondering why your business classification isn’t on the list. That’s because an LLC is only a valid business ownership structure on a state level, even though the IRS collects taxes from LLCs.

For federal tax purposes, the IRS will tax your LLC as a partnership or sole proprietorship unless you elect otherwise using IRS Form 8832 or IRS Form 2553. You can use the latter form to classify your LLC as a C corporation for federal tax purposes. If you’re wondering why you might want to do so, read on to find out how an LLC and a C corporation are similar, how they differ, and which option might be better for your company.

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What is an LLC?

A limited liability company (LLC) is a state-level company ownership structure that prevents the business owners’ personal assets from being seized to cover the company’s debts and liabilities. Many sole proprietorships and partnerships register as LLCs for this asset protection. However, only states recognize LLCs as tax classifications. For federal tax purposes, the IRS taxes multi-member LLCs as partnerships and single-member LLCs as sole proprietorships, unless you request otherwise.

Both partnerships and sole proprietorships are pass-through entities, meaning that if you are a partnership or sole proprietorship owner, all business income is added to your personal income and taxed as such. In other words, a pass-through entity does not have taxable business income. That’s why income tax is not collected on an LLC unless you request the IRS classify it as a C corporation.

What is a C corporation?

A C corporation is an ownership structure through which company owners are taxed separately instead of having the company’s income added to their personal income and taxed as such. In other words, if you own a C corporation, the amount you pay yourself from the company’s income is taxed as personal income, and the company’s income is subject to corporate income tax.

LLC vs. C corporation: How are they similar?

A C corporation and an LLC are similar in two major ways:

  • Liability protection. Both a C corporation and an LLC protect their owners’ assets from seizure to pay for debts or liabilities.
  • Registration process. To form an LLC, you must submit articles of organization to your state government, and to form a C corporation, you must file articles of incorporation with the federal government. Both forms require you to include similar information, such as your company’s name, locations, and owners. Note that since LLCs are state-level classifications, your requirements for your articles of organization will differ based on your location.

LLC vs. C corporation: How are they different?

LLCs and C corporations overall have more differences than similarities. To understand the C corporation versus LLC distinction, know these four differences:

1. Paperwork and formation

While the initial registration paperwork for an LLC and a C corporation are similar, the additional paperwork differs. An LLC must have an operating agreement, whereas a C corporation must devise detailed corporate bylaws. An LLC’s operating agreement should outline the company’s financial and operational procedures, whereas a C corporation’s bylaws should detail its members, committees, officers, and more.

The formation of a C corporation comes with additional stipulations beyond paperwork. Unlike an LLC, a C corporation must elect a board of directors, issue stocks and shares, and hold regular board and shareholder meetings. The company’s bylaws will outline all these responsibilities and address how they will be fulfilled.

2. Ownership structure

An LLC is owned by one or several people. A C corporation’s ownership is divided jointly among all its stockholders and shareholders, of whom there could potentially be hundreds or even thousands. For example, most household-name corporations are C corporations, and technically, anybody who owns stock in any of these corporations is among the company’s owners.

3. Ease of raising money

Since anybody who buys C corporation stock technically owns a share in the company, C corporations tend to have a far easier time raising money than do LLCs. That’s because ownership of C corporation stock tends to include the prospect of selling these stocks for higher prices later, so the incentive to invest in a C corporation may be higher.

You cannot expand an LLC’s ownership to include stockholders, so fundraising can be more challenging. Note that even if you register your LLC as a C corporation for tax purposes, you still cannot issue stocks in your company. To do so, you would have to form a new corporation.

Additionally, if you are seeking foreign investors, a C corporation may make obtaining foreign funding far easier. That’s because when a foreign entity invests in an LLC, the company will need to amend its articles of organization. C corporations do not need to revise their bylaws to accommodate foreign investors since anybody can buy stock in the company. However, when foreign investors purchase American real estate, they often do so under companies registered as LLCs to avoid estate taxes.

4. Taxes

By default, a C corporation pays a flat-rate corporate income tax of 21 percent. C corporation owners will also pay personal income taxes, including taxes on the dividends the C corporation pays to them. That’s why some people say that C corporations lead to double taxation.

For LLC federal tax obligations, you can choose to classify your business as either a C corporation or a pass-through entity such as an S corporation, partnership, or sole proprietorship to avoid double taxation. The choice between pass-through entity and C corporation is entirely yours to make.

Which is better: an LLC or a C Corporation?

If you prefer to avoid double taxation and pay only personal income taxes, an LLC may be better for you. Additionally, if you want to avoid excessive formation paperwork, you may prefer an LLC. On the other hand, if you need to find as many investors as possible for your company, a C corporation may serve you better. In general, know that there’s no right answer to whether an LLC or C corporation is better for you – it all depends on your circumstances.

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