Pick A Business Entity

Selecting the Ideal Business Entity From A Tax Perspective: LLC vs S CORP vs C CORP

Picking the right business entity is a crucial decision every prospective business owner has to make.

The ideal business entity should offer the following:

  • Provide limited liability to business owners
  • Minimize business taxes
  • Means of financing

To simplify this process, we will determine the right business entity from a tax perspective. In other words, the ideal business entity will be the one that produces the lowest business tax.

The three business entities we will choose from are: Limited Liability Company (LLC), S-corporation, and C-corporation.

LLC vs S CORP vs C CORP

The first process of elimination is based on the profitability of the business. If the business is not profitable, then an S corporation or C corporation are NOT suitable options. An LLC will be the right business entity to pick.

In this article, a business is considered profitable if the owner can take out a market salary from the net profits.  

An example to illustrate the profitability test is shown below:

 John is a CPA who owns a tax consulting business called Tax Guru.  If the market salary for a CPA with John’s experience is $60,000 and Tax Guru generates profits of only $40,000, then Tax Guru Fails the profitability test and should be set up as an LLC. Now if Tax Guru had profits equal to or greater than $60,000 it is considered a profitable business, and should be set up as an S Corp or a C corp in order to minimize self employment taxes.

S Corp vs C Corp

We’ve already established from the previous section in this article, that a business must be profitable in order to be set up as an S corp or a C corp.

An S Corporation is suitable if the following apply:  business owner is not in the highest tax bracket, the business owner has a significant amount of qualified dividends and capital gains, the business expects a loss in the future, and the business does not have a need for public financing.

A C Corporation is suitable if the business owner is in the highest tax bracket, or the business has a great need for public financing.

A free web based tool to help pick a business entity is http://www.pick-an-entity.com/

Disclaimer

The foregoing is intended for educational purposes only and does not constitute legal or professional advice. Nothing contained herein is intended to be used, or can be used, by any person to avoid penalties that may be assessed under federal or any state law.

© Copyright 2010, Ugonna Chukwu, CPA

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