
LLC vs. S-Corp vs. C-Corp - colbyaley
http://www.launchside.com/blog/llc-vs-s-corp-vs-c-corp/
======
molsongolden
I am sure the author of this article intended to help others make wise
tax/entity formation decisions but many of the facts mentioned are just
incorrect (tax rates and some general tax concepts). C-corps are fairly
uncommon nowadays and for good reason You are almost always going to pay more
tax in the C-corp and you will face built in gains issues when you realize
this and decide to elect to be an S-corp.

The tone of the article seems to be slightly rushed and frustrated and leads
me to wonder if the author just received unexpected news from his accountant.

One example:

Using 2013 tax rates and assuming that the taxpayer is single:

Individual Federal income tax on taxable income of $90,000 (ignoring personal
deductions/exemptions/itemized deductions, etc..) that the example taxpayer in
the article might have to pay if they were a 50% partner/member in an LLC:

Roughly $18,493 (less than 21%)

Corporate Federal income tax on $100,000 if you and your partner had a C-corp
instead and took 40k salaries then left $100k in the company.

Roughly $22,250 (About 22%)

But then if you end up not spending that money because you made a boatload of
cash the next year and want to take it out:

$3,337 (15% capital gains)

leading to a rough total of $25,587 (over 25.5%).

You might look at this example and say "hey that's just a few %" but as the
income in question grows, so does the gap.

Edit: The real reason startups might end up as corporations is for the
beneficial tax treatment investors can receive as holders of small business
stock (1202, 1244).

~~~
swampthing
_C-corps are fairly uncommon nowadays and for good reason_

This is a bit misleading for people looking to start your typical startup
(using PG's definition of 'startup'). All those startups you read about
raising money - want to know how many of them are C-corps? Just about 100%.

One thing that many people don't realize is that for many startups, those
pass-through tax benefits of LLCs and S-corps are largely illusory, since
they're not going to be profitable at that stage anyways.

Starting off as an LLC means you're going to introduce delay when you start
raising money (unless you're really on top of things and convert in advance of
fundraising), which introduces deal risk.

Yes, there is double taxation on income from C-corps, but most startup
founders aren't in it for the salary / dividends, they're in it for the
eventual acquisition / IPO (or these days, private market sales). Gains for
QSB stock held more than 5 years are now tax-free under Section 1202.

There's a whole bunch of reasons why companies end up as corporations - not
just the QSB stuff. Main street small businesses are often fine with LLCs or
S-corps. Startups (as defined by PG) should really talk with an experienced
startup attorney before going the route of an LLC or S-corp.

~~~
tptacek
You say starting off as an LLC means delay at fundraising. Unless you're
advocating running entirely unincorporated, I think this is backwards: it is
harder to convert your C corp to the form the investors will want than it is
to convert an LLC. This was my understanding before last week, when YC's
finance person confirmed it (at least as far as YC is concerned) on HN.

~~~
swampthing
Thanks for pointing that out - I should have been more careful with my words.
What I meant to say is that most startups will be better off starting as a
C-corp, provided that they use market-standard paperwork (i.e. the forms that
the major Silicon Valley law firms use, which many of them provide for free)
and don't mess anything up (which is consistent with what Kirsty was saying).
Of course, I suppose the "not messing anything up" part is harder done than
said (which is why YC companies are lucky to have Kirsty) :)

------
dylanks2
Being in a higher tax bracket doesn't lead you to pay more tax on your initial
income, only a higher rate on money above a certain threshold. That said, the
article is right in that an S-Corp or LLC sound right and are rarely a good
idea because you sometimes lose out on certain tax deductions because your
personal income is too high. Remember though, a tax bracket is a sliding
scale... see the margin tax rates table at
[https://en.wikipedia.org/wiki/Income_tax_in_the_United_State...](https://en.wikipedia.org/wiki/Income_tax_in_the_United_States)

~~~
staunch
YES! It's so annoying how few people understand this. People are never "in a
tax bracket" -- only money is!

Your first $40k may be taxed at 10% and your next $20k may be taxed at 15% or
whatever, but _you_ are not "in a tax bracket".

The idea of being "in" a tax bracket gave rise to the dumb idea that making
_more_ money can net you less after taxes, which is virtually never the case.

~~~
cmccabe
Sorry, but it may be dumb, but it's true. Making more money can lead to less
take-home pay. One really good example is if you hit the AMT (alternative
minimum tax.) "Your money" is not in the AMT-- you are. And it often means
that a raise can end up costing you money. There are also similar situations
where getting a job can mean losing out on welfare, leading to you actually
having less money to take home.

~~~
vonmoltke
Yes, the AMT is the one case where you could end up with less take-home. Its
an exception to the normal functioning of the tax code, though, and it works
by prohibiting most permissible deductions. Thus, while the statement about
the AMT decreasing take-home with increased is factually correct, this does
not happen through the bracket system. GP was clearly addressing the
misconception that people move into tax brackets and must pay higher tax rates
in all their income as a result.

Your welfare example has nothing to do with taxes. Welfare benefits are set by
gross income level with some COL and other local adjustments. Your tax status
is irrelevant.

~~~
Nrsolis
UGH.

People in the USA forget that we have TWO tax systems.

One is the regular tax system that everyone knows and loves to hate.

The other is the closest thing we have to a "flat tax" and it's called AMT. It
has different rules and different rates.

When you do taxes, you compute your tax liability using BOTH systems and you
pay the HIGHER amount. That's how it works.

I pay AMT and it sucks.

------
ksherlock
It's a little more complicated than that:

> An LLC with either a single member or more than one member can elect to be
> classified as a corporation rather than be classified as a partnership or
> disregarded entity under the default rules discussed earlier. File Form
> 8832, Entity Classification Election, to elect classification as a C
> corporation. File Form 2553, Election by a Small Business Corporation, to
> elect classification as an S corporation.

<http://www.irs.gov/publications/p3402/ar02.html>

~~~
Nrsolis
Nobody does this. You give up the benefits of pass-thru taxation that you GAIN
with an LLC. You're essentially volunteering to be taxed TWICE if you make
this election.

------
tpsreports3
With all due respect, this article really isn't that great.

Here's the real difference, stated succinctly:

LLCs and S-corps are pass-through entities that aren't generally subject to
regular corporate income tax like C-corps are. (But there are exceptions, like
NYC, which taxes S-corps as if they were C-corps.) Additionally, C- and
S-corps can issue stock to owners and investors, while LLCs cannot, but
S-corps are restricted in various ways that C-corps are not, like not being
able to issue stock to foreign investors, having only one class of stock and
no more than 100 stock owners.

VCs and Angels will not invest in an LLC, and the process to convert an LLC to
C-corp is (or was, last time I checked) difficult, typically involving the
formation of a brand new C-corp that buys the LLC and then dissolves the
assets of the LLC into itself. I believe Joel once mentioned that FogCreek
went through this process years ago, and it was not very pleasant. By
contrast, it is trivial to convert an S-corp to a C-corp with one form (IRS
Form 1120).

If you ever plan on issuing stock or taking outside investment, start out as a
C-corp or S-corp. If you plan on running a business that won't (or can't)
issue stock or accept outside investment (like a law firm or medical
practice), then form an LLC.

~~~
eli
I started as an LLC and had to covert to a C-Corp. Paid a lawyer to do it, but
it really wasn't hard at all. Of course we also didn't have many assets at
that point.

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thatswrong0
This is an aside, but needs to be said: if you're going to offer a mobile
specific layout for your website, test the damn thing first. It's extremely
jarring to have share buttons on the left side covering up the first letters
of each line. I can't even zoom out so that the text fits. If you're really so
desperate for people to talk about your post that you'll cover up the post in
order to achieve that, at least put it at the top.

------
Afforess
What isn't mentioned here is that an LLC is relatively straightforward to set
up, an average Hacker News reader could set one up in their state with a few
hundred dollars and no lawyer. S-Corps are more complicated (you will need a
lawyer), and C-Corps are VERY complicated (you will want at least 2 lawyers).
The amount of legal fees and time spent creating the different corporations
varies immensely. It's not as simple a comparison as just "tax code". If you
are not sure what kind of corporation you want to set up, I highly recommend
you spend a few hundred dollars and consult a lawyer for advice. The internet
is a terrible place for legal advice.

Source: I own an LLC, and consulted a lawyer about C-Corps and S-Corps.

~~~
georgemcbay
"What isn't mentioned here is that an LLC is relatively straightforward to set
up, an average Hacker News reader could set one up in their state with a few
hundred dollars and no lawyer."

This is true but it should also be noted that in some states you can get taxed
a significant amount of money per year on your LLC. California, in particular,
has an $800 minimum tax per year on LLCs, regardless of whether you've earned
a single dime.

$800 a year isn't much if your LLC is an actual money making venture, but is
pretty significant if you are just using it for what amount to basically side
projects.

~~~
ericabiz
California's $800 minimum corporate tax also applies to S-corps and C-corps.
Also, to correct a common misconception I often hear (not in your particular
post, but in general when I talk about this), registering your corporation in
another state does _not_ exempt you from the minimum tax. If you, the
corporation's officer(s), live in California, you must register with the state
of CA as a foreign corporation (foreign in this instance meaning out-of-
state), and pay the $800 minimum tax.

Do not try to get around this--California will hunt you down.

------
jhancock
A Georgia LLC can choose to have some or all of its net income left in the
company and taxed as C-Corp with the remainder distributed to shareholders as
S-Corp. Its very flexible and there is no preset position. You look at your
cash position come tax time and decide how best to deal with it.

------
eldavido
One problem with the reasoning in this article: reinvested earnings usually
don't sit on the company's balance sheet as cash -- they're reinvested into
the business as wages, advertising, and other expenses, all of which reduce
profit (but increase long-term enterprise value).

If you own a lot of proprietary IP, go with the C corp, otherwise if you're
running an asset-light cash business where most of your revenue flows through
to profit or pays short-term expenses (e.g consulting), a pass-through entity
(LLC/S Corp) is probably better.

~~~
csense
1\. Why is the C corp better for companies with a lot of proprietary IP?

2\. Which way would you classify the typical software/web startup?

One of a typical web or software startup's most important assets is its
product (which argues that they "have a lot of proprietary IP").

But they are also "asset-light cash business" in the sense that they don't
have to have a ton of buildings or physical inventory like e.g. a
manufacturing startup would, their physical footprint might consist entirely
of one small leased office with a few computers.

~~~
eldavido
I was given the advice I repeated above by an accountant a while ago.
Admittedly, I don't recall the reasoning as clearly as I did when first told,
but I think the basic idea is that it's more tax efficient to reinvest profits
into a C corporation than a partnership or other pass-through entity.

Let's puzzle it out. C corporation math:

$1 revenue in let's assume a 50% operating margin, gross profit on $1 of
revenue = $0.50 throw in another 10% for SG&A (sales, general, and
administrative -- stuff your company does that isn't cost-accounted to
production), we now have $0.40

Delaware has an 8.7% corporate income tax, reducing our $0.40 to 36.52 cents
of free cash, which can be paid out to investors as a dividend or retained in
the company for future growth.

If paid out, qualifying dividend tax would apply, leaving our investor with
about 31 cents of profit. If kept in the company, shareholders would have
36.52 cents to reinvest.

Pass-through math: $1 revenue in Net profit: 0.40 (same as above)

Irrespective of whether profit is distributed or retained, and assuming a 28%
individual marginal rate for partners, the partnership is left with 28.8 cents
of post-tax profit that they can reinvest or distribute (take out for
themselves). A few points from this example:

It's basically a wash tax-wise (28.8 cents vs. 31) if the profits are
distributed. If profits are reinvested, the C corp has 36.5 cents of the
original dollar left vs. 29-31, which will compound very significantly over
time. So for a business that pays out most of its profits each year and
doesn't reinvest (e.g. typical consulting company), it's likely better and
simpler to use a partnership, whereas the C corp is better served for "asset
heavy" companies with things that depreciate over time.

Software is tricky because even though it's an "asset" in every sense of the
term ("probable future economic benefit", can be sold, etc.) most accounting
systems don't recognize it as such. You should really get a CPA's advice on
this, but I think the bottom line is, if you're going to (1) earn profit (most
startups don't for a long time) and (2) reinvest a lot into the company,
you're likely better off with a C corp, otherwise, for a cash business where
most profits are paid out right away (law firm, ad agency, medical practice)
you're better with a passthrough entity.

Hope this helps

------
pwman
Author is likely incorrect about the C Corp retained earnings taxes, the tax
owed for 100k of profit for Federal only would be more like $22,500 as the 15%
rate is only for your first 50K of profit.

The corporate tax rate is very high and should really be thought of as 35% if
you have meaningful profit.

You may also be able to defer profit if you're delivering service after you're
paid for it (and you should be doing this), this keeps more money in the
company without paying the taxes immediately. A far more important lesson.

------
GBond
Warning for anyone reading. There is a lot of wrong information in this thread
as well as the OP. If you seek incorporation guidance, consult a professional
attorney and CPA.

------
Axsuul
_Here’s the snag. If you are using a pass-through entity such as a LLC or
S-Corp that money you are leaving in the company (retained earnings) is
personally taxable to you in proportion to your ownership of the corporation._

LLCs and S Corps can be taxed like a corporation and not as a pass-through
entity.

------
CamperBob2
Why does any of this matter? If you need a particular corporate structure for
an equity investment or other purposes, you form a new corporation that buys
the assets of the old business, and life goes on.

A C Corp is absolutely nuts for anyone starting out, unless you just want to
pay your taxes twice.

~~~
Fundlab
Can you expand on this?

~~~
CamperBob2
Not really, it just seems pretty obvious to me. A lot of founders seem to get
hung up on whether to use an LLC, an S corp, a C corp, or some other
structure. In my experience the question can be answered pretty trivially:
create an LLC unless there's a reason not to create an LLC, in which case you
probably want a subchapter-S corporation.

The issue of where to incorporate seems to be more important for C corps where
the taxes aren't reported directly on the owners' returns. IMHO it's a waste
of time and energy to try to anticipate the exact corporate structure that a
future VC round, IPO, etc. will require. Start out by considering only what
makes sense from your own tax perspective, then re-elect/recreate the business
later on if you need to, registering it in another state if necessary.

------
ehsanf
The article suggests, but doesn't explain why LLC / S-Corp is better if you
are taking all the money out.

It feels to me that if you don't have to retain any money, then they both
collapse to the same situation more or less. The only difference being C-Corp
needing more expenses in accounting (and maybe legal) to just keep the books
in order, but that is not a significant factor.

~~~
lholoubek
If you plan on taking the money out of the company immediately, the LLC/S-Corp
is better because the company doesn't pay any tax on that income – it "passes
through" to the members as regular income. Therefore, it's only taxed one
time. With a C-Corp, the corporation pays taxes on its income for the year,
and any money paid out to the shareholder is taxed at 15%. Thus, the actual
earnings of the corporation are subjected to double taxation, which the
LLC/S-Corp can avoid. The potential problem with an LLC that he's referring to
is that LLC members are taxed on their share of annual income, whether or not
it is actually distributed out.

------
camz
the best advice i can give you after answering so many tax questions in HN is
to ask a professional... especially after reading this =)

------
will_brown
_This is not legal advice.

The article focuses on a very small tax issue that should not be determinative
of business structure. The way a Start-up should decide to form a business
generally should be as follows:

1\. State - generally always choose the State the Founder is physically
located. If you choose Delaware or another State you are not physically
located, you must "qualify" your business to do business in every State you
have a physical presence - failure to qualify may negate any protections
offered by the business structure.

2\. Structure -(Corp (S or C) vs LLC) This is determined on a two part
analysis: First, I start with liability, CPAs typically only look at the tax
issue, you want to ensure the Founder(s) will not be liable for business debts
and the business can not be liable for Founder's personal debts. Example, I
would always advise against a "single member" LLC because an LLC is considered
a Partnership, thus Courts will not enforce Partnership protection where there
are no Partners (ie, single member) and the LLC can be liable for Founder's
personal debts - on the other hand a CPA will usually recommend single member
LLCs because they are taxed like a sole proprietorship(make filing taxes
really easy). Second, should be the tax issue, if multiple Founders I suggest
LLC, especially when there are foreign Founders, if it is a single Founder
then I suggest Corp. and S status if qualified.

3\. Cost- This should never be determinative but taken into consideration. The
cost of forming/qualifying Corp and LLC can vary greatly among the States.
Additionally, compliance (annual reports, state taxes) among the States can
vary as greatly as well as the cost of compliance and the penalties for
failure to timely file can be very costly.

_ __I know the word in SV is that Start-ups must be C-Corps incorporated in
Delaware in order to receive funding. My thought is that if a Start-up is
already incorporated/organized and has not received funding the Founders can
easily: 1. "Domesticate" their business entity to Delaware, if an LLC perform
a Conversion to a C-Corp., or 2. Dissolve and have the investors attorney's
draft the new Delaware Articles of Incorporation.

As to the tax issue discussed I did not notice the article discuss that an LLC
can be taxed as a C-Corp and if qualified elect S status. Also, playing the
game of minimizing salary and maximizing distributions, while obviously
beneficial because an owner only pays payroll and FICA on salary not on
distribution, becomes a dangerous game that may result in the IRS knocking on
the door. However, to the best of my knowledge the IRS has only ever gone
after S-Corporations in such situations and have not set a precedent of going
after LLCs.

~~~
hkhanna
> Example, I would always advise against a "single member" LLC because an LLC
> is considered a Partnership, thus Courts will not enforce Partnership
> protection where there are no Partners (ie, single member) and the LLC can
> be liable for Founder's personal debts

This is not true. A single-member LLC gets the benefit of the personal
liability shield.

However, as with any limited liability form, you can get the liability shield
pierced if you don't properly organize and operate the LLC.

Because a single-member LLC has only one member, it might more likely to get
the liability shield pierced since there isn't more than one party watching
the documents and "formalities." (I put formalities in quotes because LLCs
have very few formalities).

Source: Advising Small Business by Steven Alberty, Section 7:17.

~~~
will_brown
>Source: Advising Small Business by Steven Alberty, Section 7:17.

Not to be condescending but good luck citing that in Court.

>>Example, I would always advise against a "single member" LLC because an LLC
is considered a Partnership, thus Courts will not enforce Partnership
protection where there are no Partners (ie, single member) and "the LLC can be
liable for Founder's personal debts"

Re-read what you quoted, specifically focus on, "the LLC can be liable for
Founder's personal debts". Your response: This is not true. A single-member
LLC gets the benefit of the personal liability shield. Allow me to return
favor and say "this is not true." While the Owner of a single member LLC may
be protected against the LLC liabilities, that same LLC can be liable for the
personal debt/judgments of the single member Owner.

The Florida Supreme Court recently issued the Olmstead v. Federal Trade
Commission case. The case's holding is that F.S. 608.433 (4) allows a court to
order a debtor to surrender "all right, title, and interest" in the debtor's
single-member LLC to satisfy an outstanding judgment, unlike many other states
where the sole remedy is a charging order.

------
sellardour
Firstly, I am skeptical that the author uses the word 'thru' so much.

Secondly, if I were to take all the money personally, and then say, buy
something useful for myself that my business could really use too, instead of
retaining money on paper, does that not work?

~~~
csense
If you do this, there's a good chance you're throwing away the main benefit of
having a corporation!

Specifically, "intermingling of assets of the corporation and of the
shareholder" [1] is a reason that can be used in court by creditor(s) of your
business to hold you personally liable for its debts.

[1]
[http://en.wikipedia.org/wiki/Piercing_the_corporate_veil#Uni...](http://en.wikipedia.org/wiki/Piercing_the_corporate_veil#United_States)

------
hayksaakian
Good overview showing what's really important.

Now it makes sense to my why big companies have all of these.

eg: amazon inc AND amazon llc.

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supercanuck
S Corps are referred to as "Professional Corporations". Their intended purpose
was for Doctors, Lawyers, Consultants etc. and other people looking for
liability protection for services they provide. I believe in some states they
even restrict the number of shareholders.

Take that for what it's worth.

~~~
joshuaheard
A Professional Corporation is different from an S-Corporation. The
S-Corporation is an IRS classification of a regular corporation, while
Professional Corporations are a different type of corporation created at the
state level. Professional Corporation owners are limited to the profession it
is aimed at. So they must be, for example, all lawyers or all doctors. They
are generally used for professions that require a state license.

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IgorPartola
OT rant. The goddamn social sharing toolbar on the left covers up a
paragraph's worth of first 2-3 characters on mobile Safari.

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jborden13
That's why a sole proprietorship is best</joke>

