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Florida Business Entity Selection – The benefits and pitfalls of Corporations, S-Corporations, and Limited Liability Companies

Understanding and selecting an appropriate entity is an important part of beginning a new business venture. The pros and cons of the legal, tax and operational aspects of each business entity should carefully be considered when deciding what type of business entity to use. Often when selecting a business entity, working closely with both a CPA and an attorney are beneficial in determining the best fit for your business.

THE C Corporation

The C Corporation is organized by shares and allows for sophisticated options when it comes to dividing ownership. The key difference with a C Corp is that its income is taxed on two levels: the company is taxed on the corporate level, and then the profits that get distributed to the shareholders get taxed on the shareholder level. From a corporate housekeeping standpoint, C Corporations have more formalities than an LLC and S Corporation, and are more expensive to maintain.

Most small to midsize business clients that I work with end up taking the S-Corp or LLC route.  For that reason focus will be on the S Corporation and the Limited Liability Company.  

The S Corporation

An S Corporation is best described as a hybrid between an LLC and C Corporation. Like the LLC, it is a pass-through entity where all of the profits and losses flow to the owners of the company, but the company itself is owned by shareholders. The key advantage to an S Corp over an LLC is that the owners of the S Corp can pay themselves a reasonable salary (subject to FICA tax and other withholding requirements), but the remaining net earnings can be distributed as passive dividend income not subject to self-employment tax. 

However, to make matters even more interesting, LLCs can elect to be classified as an S Corporation in the eyes of the IRS to avail themselves of the tax benefits of an S Corp. That provides the business owner with the flexibility of administration that comes with an LLC, and the flexibility of tax treatment of business income with the S Corp.

The LLC

The LLC or Limited Liability Company is the simplest form of corporate entity. The LLC has become a favorable choice for small businesses because they are inexpensive to establish, easy to manage and still offer protection from liability stemming from the actions of the company.

LLCs are pass-through entities, meaning that the profits from the company pass directly through the company to the owners. Instead of the company itself being taxed and having to file a tax return, the individuals who own the LLC receive a percentage of the profits based on their ownership share (their “pro-rata” share), and then they report that income (less deductible business expenses) on their personal income taxes. Of course, if the business is losing money the owners report that loss. Generally, everything flows from the LLC to the business owner, and the profits get taxed one time at the individual level.

LLCs are generally favored because they are inexpensive to form and can be operated with few corporate formalities. Used properly, they can insulate you from personal liability and allow you to divide ownership between multiple parties without excessive formalities. The advantage of an LLC over an S Corp is that there are less paperwork and corporate formalities with establishing and maintaining an LLC.  However, if the business starts generating a lot of money, it is all reported as ordinary income and subject to self-employment tax.