Choosing the right legal structure is one of the first big decisions a business owner makes, but the startup phase shouldn’t be the last time you think about it. As your company grows, evolves, or shifts direction, your original entity choice might no longer be the best fit. Regular entity reviews can enhance tax savings, liability protection, and alignment with your business goals.
Here’s an overview of common entity types—LLC, S corporation, and C corporation—with some guidance on which might serve you best.
LLC: Limited Liability and Flexibility
A limited liability company (LLC) is a popular choice for small businesses due to its flexibility and simplicity. It provides liability protection for its owners (called “members”), and income typically flows through to the members’ personal tax returns, avoiding corporate-level taxation.
Pros:
- Simpler to form and maintain—LLCs don’t have the same legal requirements for corporate governance or record-keeping.
- Pass-through taxation—LLC profits and losses can be taxed as self-employment income, which simplifies the tax process.
- Flexible ownership and management structure—Owners can manage the business themselves or appoint managers, and a formal board of directors and officers isn’t required.
- Limited personal liability—LLC members’ personal assets are protected if the corporation defaults or becomes insolvent.
Cons:
- Pass-through tax rates might result in higher overall tax bills—While the top personal tax rate is 37%, the corporate rate is 21%. However, the Qualified Business Income deduction can reduce the top rate for qualifying pass-through income to 29.6%. Yeah, it’s complicated. You’ll need to determine the point at which an S corp election makes sense. (See the next section for more on S corps.)
- Borrowing can be more difficult—The limited liability protection of the LLC structure means borrowing can be more expensive, and lenders may require loans to be secured with personal assets.
- Attracting investors can be challenging—Venture capital investors generally prefer to avoid LLCs because of the looser governance structures and complications created by pass-through taxation.
- Variances by state—Some states impose additional LLC fees or taxes.
When It’s a Good Choice:
LLCs are great for small to mid-sized businesses that don’t need to issue stock, want straightforward tax treatment, and prefer fewer formalities.
S Corporation: Tax Efficiency for Growing Businesses
An S corporation (or S corp) is not a legal entity itself, but a tax election available to eligible LLCs or corporations. It allows profits (and some losses) to pass through to owners’ personal returns while potentially reducing self-employment taxes by paying owners a reasonable salary and taking additional profits as distributions.
Pros:
- Taxation flexibility—Owners can elect pass-through taxation or can choose to pay themselves a salary and access additional profits as shareholder distributions.
- Enhanced ability to raise capital—S corps can raise funds by issuing shares of company stock. This formal share structure makes it easier to attract investors compared to LLCs, which typically must admit investors as members and adjust their operating agreements accordingly.
- Easier ownership transfer—S corp shares can generally be transferred or sold without dissolving the business, facilitating investment and succession planning.
Limitations:
- Ownership restrictions—S corps are limited to 100 shareholders, and only one class of stock is allowed.
- Ownership restrictions—Shareholders must be U.S. citizens or residents; no foreign or corporate entity shareholders are allowed.
- Formalities—S corps must comply with rules regarding the adoption of bylaws, board meetings, recordkeeping, and stock issuing.
- Payroll—Paying salaries requires additional administrative burdens of payroll tax filing and compliance.
When It Might Make Sense To Switch:
If your LLC is generating consistent profits and your self-employment tax bill is rising, electing S Corp status may lead to tax savings. But be sure to factor in the added administrative responsibilities (like payroll and filings).
C Corporation: Built for Scale
A C corporation (C corp) is a separate legal entity from its owners and pays taxes at the corporate level. Unlike LLCs and S corps, profits don’t pass through to owners unless paid as dividends, which can lead to double taxation—once at the corporate level, and again at the shareholder level.
Advantages:
- No ownership restrictions—C corps have no limits on shareholders or types of investors, including foreign investors and other corporations.
Attractive to investors—Because of their governance and legal structure and ability to issue multiple classes of stock, C corps are attractive to venture capitalists and institutional investors. - Tax benefits—C corps offer potential tax advantages, such as the Qualified Small Business Stock (QSBS) exclusion, which allows investors to exclude a significant portion of capital gains from taxation if certain conditions are met. C corps can also retain earnings for growth without immediate tax consequences for shareholders.
- Employee equity incentives—C corps can offer stock options and fringe benefits that help attract top talent.
- A launch pad for something bigger—C corps are the standard structure for companies whose longer-term strategy is to be acquired or make an IPO.
Challenges:
- Double taxation of dividends—The C corp pays corporate income tax on its profits, and if it distributes some or all of the after-tax profits to shareholders as dividends, those dividends are taxed again on the shareholders’ personal income tax returns.
- Greater overall tax complexity—C corps are subject to federal, state, and sometimes local corporate income taxes, as well as state franchise taxes (if you do business in multiple states), payroll, sales, and property taxes depending on business activities and locations. The complexity and cost of compliance with these tax obligations are significant.
- More formalities and reporting requirements—C corps have the most rigorous formalities and reporting requirements, including mandatory meetings, detailed recordkeeping, multistate compliance, and strict governance rules.
When It Makes Sense:
C corps are often the best choice for startups planning to scale quickly, raise significant outside capital, or reinvest profits back into the business rather than distribute them.
How to Know if It’s Time for a Change
Here are some signs that your business might benefit from an entity review:
- You’ve grown significantly. Tax obligations, liability risks, and fundraising needs can change with scale.
- Your ownership structure is evolving. Bringing on partners, investors, or changing member roles may affect the best-fit entity.
- You’re exploring new markets or funding. Some investors require C corp status; others may prefer simpler LLC arrangements.
- Your tax burden feels too high. Strategic restructuring (like an S corp election) could reduce self-employment taxes or improve deductions.
- You’ve never reviewed your structure since forming. Even if nothing seems broken, your business may have outgrown its original framework.
Let Strategy Lead the Structure
There’s no one-size-fits-all answer when it comes to business entities. The right structure balances tax efficiency, legal protection, growth goals, and administrative complexity. What worked when you launched your business might not be ideal now. A thoughtful entity review—ideally done annually or after any major business change—can save you money, simplify operations, and position your business for the next phase of growth.
Need help reviewing your current entity? Our team is here to guide you through the process and help you make a decision that positions your business for success.