9 ms·

LLC vs. S-Corp vs. C-Corp

105 points by colbyaley 14y ago

jborden13 14y ago
That's why a sole proprietorship is best</joke>
hayksaakian 14y ago
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.
dylanks2 14y ago
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_States https://en.wikipedia.org/wiki/Income_tax_in_the_United_State...
- Afforess 14y ago
  This is correct, and worth pointing out, because the OP has this line: >So now you owe an extra 10% on your $40K salary which is $4K. And you also owe 35% on that $50k which is around $18K. Which is false. The extra 50k is taxed more than your first 40k. Your overall effective tax rate increases, but it's incremental. Your first 40k is taxed the same with or without the extra 50k, but the extra 50k is taxed at a higher rate because it's in a higher marginal rate.
- staunch 14y ago
  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 14y ago
    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 14y ago
      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 14y ago
        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.
      - cmccabe 14y ago
        There are a ton of places in the tax code where making more money results in you keeping less of it. For example if you sell more than X dollars worth of goods on eBay, you have to start paying tax, which will cost you dear. So the jump from X to X+1 ends up costing you. I think X = $500, but maybe they changed it. The IRS even reduces your taxes if you lose money in the stock market, if your business property depreciates, and so forth. I like to refer to those cases as "the government paying you to be a loser." Just another case where doing better means you do worse. Let's not even try to pretend this is a fair or well-designed system. Even Warren Buffet, surely one of the greatest beneficiaries of the system, has spoken out against it.
ehsanf 14y ago
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 14y ago
  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.
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ksherlock 14y ago
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 http://www.irs.gov/publications/p3402/ar02.html
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- Nrsolis 14y ago
  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.
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jhancock 14y ago
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.
Afforess 14y ago
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 14y ago
  "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.
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  - ericabiz 14y ago
    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.
- jforman 14y ago
sellardour 14y ago
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 14y ago
  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#United_States http://en.wikipedia.org/wiki/Piercing_the_corporate_veil#Uni...
supercanuck 14y ago
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.
- molsongolden 14y ago
  A PC is actually different from an S Corp! I haven't read the article yet but felt the need to reply to this. States also don't have S-corps, they are a construct of the IRS and an LLC or a C-corp can elect to be taxed as an S-corp but it doesn't change their legal entity form. The shareholder limit is 100 and there are a few other nuances but the general idea is that you can elect for your corporation to be taxed as a flow through so as to avoid double taxation.
- joshuaheard 14y ago
  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.
pwman 14y ago
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.
thatswrong0 14y ago
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.
camz 14y ago
the best advice i can give you after answering so many tax questions in HN is to ask a professional... especially after reading this =)
molsongolden 14y ago
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).
- will_brown 14y ago
  >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. I think you are correct few start-ups and small businesses will ever incorporate and be taxed as a C-Corp. However, there are limitations to the S-Corps, such as a max of 100 shareholders and I think prohibitions foreign shareholders, so any public company is generally going to be C-Corp, the major exception I can think of are publicly traded banks who are N.A.s
  - eli 14y ago
    My understanding is that a C-Corp also has much simpler paperwork around tax time.
eldavido 14y ago
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 14y ago
  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 14y ago
    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
Axsuul 14y ago
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.
tpsreports3 14y ago
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 14y ago
  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.
will_brown 14y ago
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.
- 14y ago
CamperBob2 14y ago
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 14y ago
  Can you expand on this?
  - CamperBob2 14y ago
    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.
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kudwitt 14y ago
This is well intentioned, but incorrect. For startups and small businesses, as long as you do not have outside professional investors (like VC's) always use LLC's. The solution to the problem described by Chris is simple: do your accounting on a cash and not an accrual basis. That way the only way you will ever pay taxes is if you have the cash. LLC's are designed to: 1) avoid double taxation (at the personal and corporate levels) and 2) allow you to pass losses through so that you can reduce your personal tax liability. As was noted there are many very large brands that use LLC's for certain products too such as Amazon, NFL, A&E Television and probably thousands more. Finally, speak to an accountant so that they can walk you through the details.
IgorPartola 14y ago
OT rant. The goddamn social sharing toolbar on the left covers up a paragraph's worth of first 2-3 characters on mobile Safari.
spqr 14y ago
OP does not touch on tax shelters such as the Individual 401k. I am a W2 employee and max out my social security tax through the W2 (by far). I then have an LLC that I do side consulting with. My wife doesn't have a job so she does the billing for my LLC. I max out the employee portion of my W2 401k (17,500 this year) so can only contribute employer portion to my Individual 401k (20% of profits). With my wife, since she doesn't have a 401k at a W2 employer I can shelter 17,500 employee portion for her and then the employer portion on top of that. Essentially the max you can put in for an individual 401k is 49,000 per year if I remember correctly. You can open an individual 401k at either Vanguard or Fidelity - it's very easy. In many states, the individual 401k receives similar creditor protection to regular 401ks. Consult an attorney and tax advisor before taking action on what I have written. This is neither tax or legal advice and I am in fact an idiot who knows nothing about anything.
GBond 14y ago
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.

105 points by colbyaley 14y ago

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

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.

dylanks2 14y ago

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_States https://en.wikipedia.org/wiki/Income_tax_in_the_United_State...

Afforess 14y ago
This is correct, and worth pointing out, because the OP has this line: >So now you owe an extra 10% on your $40K salary which is $4K. And you also owe 35% on that $50k which is around $18K. Which is false. The extra 50k is taxed more than your first 40k. Your overall effective tax rate increases, but it's incremental. Your first 40k is taxed the same with or without the extra 50k, but the extra 50k is taxed at a higher rate because it's in a higher marginal rate.
staunch 14y ago
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 14y ago
  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 14y ago
    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 14y ago
      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.
    - cmccabe 14y ago
      There are a ton of places in the tax code where making more money results in you keeping less of it. For example if you sell more than X dollars worth of goods on eBay, you have to start paying tax, which will cost you dear. So the jump from X to X+1 ends up costing you. I think X = $500, but maybe they changed it. The IRS even reduces your taxes if you lose money in the stock market, if your business property depreciates, and so forth. I like to refer to those cases as "the government paying you to be a loser." Just another case where doing better means you do worse. Let's not even try to pretend this is a fair or well-designed system. Even Warren Buffet, surely one of the greatest beneficiaries of the system, has spoken out against it.

ehsanf 14y ago

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 14y ago
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.
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ksherlock 14y ago

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

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Nrsolis 14y ago
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.
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jhancock 14y ago

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.

Afforess 14y ago

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 14y ago
"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.
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- ericabiz 14y ago
  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.
jforman 14y ago

sellardour 14y ago

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 14y ago
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#United_States http://en.wikipedia.org/wiki/Piercing_the_corporate_veil#Uni...

supercanuck 14y ago

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.

molsongolden 14y ago
A PC is actually different from an S Corp! I haven't read the article yet but felt the need to reply to this. States also don't have S-corps, they are a construct of the IRS and an LLC or a C-corp can elect to be taxed as an S-corp but it doesn't change their legal entity form. The shareholder limit is 100 and there are a few other nuances but the general idea is that you can elect for your corporation to be taxed as a flow through so as to avoid double taxation.
joshuaheard 14y ago
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.

pwman 14y ago

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.

thatswrong0 14y ago

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.

camz 14y ago

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

molsongolden 14y ago

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).

will_brown 14y ago
>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. I think you are correct few start-ups and small businesses will ever incorporate and be taxed as a C-Corp. However, there are limitations to the S-Corps, such as a max of 100 shareholders and I think prohibitions foreign shareholders, so any public company is generally going to be C-Corp, the major exception I can think of are publicly traded banks who are N.A.s
- eli 14y ago
  My understanding is that a C-Corp also has much simpler paperwork around tax time.

eldavido 14y ago

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 14y ago
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 14y ago
  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

Axsuul 14y ago

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.

tpsreports3 14y ago

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 14y ago
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.

will_brown 14y ago

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.

14y ago

CamperBob2 14y ago

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 14y ago
Can you expand on this?
- CamperBob2 14y ago
  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.
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kudwitt 14y ago

This is well intentioned, but incorrect. For startups and small businesses, as long as you do not have outside professional investors (like VC's) always use LLC's. The solution to the problem described by Chris is simple: do your accounting on a cash and not an accrual basis. That way the only way you will ever pay taxes is if you have the cash. LLC's are designed to: 1) avoid double taxation (at the personal and corporate levels) and 2) allow you to pass losses through so that you can reduce your personal tax liability. As was noted there are many very large brands that use LLC's for certain products too such as Amazon, NFL, A&E Television and probably thousands more. Finally, speak to an accountant so that they can walk you through the details.

IgorPartola 14y ago

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

spqr 14y ago

OP does not touch on tax shelters such as the Individual 401k. I am a W2 employee and max out my social security tax through the W2 (by far). I then have an LLC that I do side consulting with. My wife doesn't have a job so she does the billing for my LLC. I max out the employee portion of my W2 401k (17,500 this year) so can only contribute employer portion to my Individual 401k (20% of profits). With my wife, since she doesn't have a 401k at a W2 employer I can shelter 17,500 employee portion for her and then the employer portion on top of that. Essentially the max you can put in for an individual 401k is 49,000 per year if I remember correctly. You can open an individual 401k at either Vanguard or Fidelity - it's very easy. In many states, the individual 401k receives similar creditor protection to regular 401ks. Consult an attorney and tax advisor before taking action on what I have written. This is neither tax or legal advice and I am in fact an idiot who knows nothing about anything.

GBond 14y ago

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.