LLC vs S-Corp vs C-Corp
Which NJ Business Entity Is Right For You?
LLC vs S-Corp vs C-Corp? Most of the time when clients ask me this question, the quick answer is the New Jersey LLC for NJ residents (they are cheaper to setup, easier to operate, and offer liability protection) … But there are many issues to consider to decide which NJ business entity is best for your business; and depending on your business goals the LLC may NOT be the best choice or even a possible choice. (Please be advised this article is for educational purposes only and nothing herein should be considered legal advice or tax advice… If you want me to give you specific help please call me at (201) 431-6276.)
Here is a quick comparison chart:
Factors to Consider When Choosing Between LLC vs S-Corp vs C-Corp.
First and foremost, here are the factors that you need to consider when deciding upon the New Jersey LLC vs S-Corp vs C-Corp: Liability, taxes, formation costs, operational flexibility, control, raising money, and state concerns.
1) Liability. One of the main reasons to form a NJ business entity before starting a business is to shield your personal assets. The law views an entity (such as an LLC or corporation) as a separate person. The entity has its own legal rights separate from that of its owners – it can sue, be sued, own and sell property, and sell the rights of ownership in the form of stock (corporations) or membership units/percentages (LLCs).
What this means is that if the LLC/corporation incurs debt or gets sued by a customer, those debts and any judgments from a customer lawsuit will NOT become debts/judgments of the member/shareholder/owners of the LLC/corporation. (This is of course assuming that the LLC/corporation is run properly with annual meetings and no comingling of personal funds.) The shareholder/member will only be liable for the value of their personal investment (or contribution) to the company.
Translation: No customer/contractor/employee can sue you and take your house or personal car.
2) Taxes. Two main differences in taxation here… One option is pass through taxation, where any profits of the LLC/corporation do not get taxed at the entity level and are instead ‘passed through’ to the members of the LLC (or shareholders of the corporation). The second option is double taxation, where the profits from the LLC/corporation are first taxed at the corporate level and then taxed a second time upon distribution to the members/shareholders (usually at a lower tax rate).
Believe it or not there are several situations where double taxation is desirable. For example, there are certain tax planning techniques that companies can utilize to move taxable income out of high tax states to lower tax states. For the sake of discussion, let’s say I own a NJ pizza company with many stores… I can form a Nevada entity (where there are no state corporate taxes), assign the ownership of all the company’s ovens, computers, and other assets to the Nevada entity and then lease back the assets to my New Jersey company. With a plan such as this the lease payments reduce my New Jersey taxable income, and I can invest the money in the Nevada entity in the stock market or loan that money to myself to purchase another pizza store.
This is similar to what Nike and Apple do on an international level. (For example, the Nike Swoosh logo is technically owned by a Dutch subsidiary of Nike.)
3) Formation Costs. The initial cost of forming a NJ business entity must also be taken into account. Every State in the United States has different formation costs, requirements and ongoing fees that must be taken into account. For example, in my home State of New Jersey it only costs a $125.00 filing fee to register an LLC with the State and there are no notice requirements. However, in New York there is a notice requirement where anyone forming an LLC is required to put notice in the local newspaper of such formation (which can cost an additional $1000-$2000 if it is formed in the 5 major boroughs of NYC). Thus, in NYC it is usually better to form a corporation and elect S-Corp status.
4) Operational Flexibility. Once an entity has been formed, how difficult and complicated is it to operate? The rules and laws for LLCs differ vs corporations. You will learn more about this later in this article, but generally speaking a corporation is much more complicated to run and thus more costly in time, fees and expenses.
5) Control. Depending on the type of entity you select, there are rules and laws that govern how the entity is required to operate. For example, if you want primary control of the activities of the business, an LLC might be the best choice for you. However, a corporation from its formation is constructed to have a board of directors that makes the major decisions for the company. A single person can control a corporation, especially at its inception, but as it grows, so does the need to operate the corporation as a board-directed entity per State and Federal regulations. Even if you are running a small corporation, the same rules intended for larger corporations must still be followed.
6) Raising Money. The LLC vs S-Corp vs C-Corp question is further complicated if you want to raise PROFESSIONAL money. What exactly is professional money? It is investment from people or entities whose day to day job is investing in companies. The simplest example is the venture capitalist or “VC”. VCs primarily invest in technology companies that they hope will be a major corporations in the next 5-10 years (think Facebook).
The issue with LLC vs S-Corp vs C-Corp in this context is that VCs are primarily funded by non-profit corporations (college endowments and large retirement funds). Non-Profits cannot directly/indirectly invest in entities that have pass through taxation (LLCs) and therefore if you are starting a business that you envision to be the next Facebook, you will need to choose a C-Corporation.
7) State Concerns. It also may be important which State you choose to form your entity. In furtherance of the previous paragraph’s discussion of VCs, it is also important to note that professional money will generally only invest in companies that are founded in Delaware (with only a few exceptions). The reason for this is that Delaware has very favorable business protection laws and a court system that is used to dealing with complicated business disputes.
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What Is The Difference Between LLC and S-Corp and C-Corp?
The Limited Liability Company (LLC).
Limited Liability Companies are formed by filing a Certificate of Formation (which is like the company’s birth certificate) with the Secretary of State of New Jersey. Then an EIN number is obtained from the IRS for the LLC (think of this as the social security number for the LLC). Finally, the company is registered with the State for tax purposes.
Overall, the Limited Liability Company provides the best of everything; liability protection, the ability to choose pass through or double taxation, and extreme flexibility in operations. Especially in New Jersey, they are the default ‘go to’ entity to form, especially with real estate transactions. More specifically:
Liability. LLCs offer limited liability protection similar to a corporation. Thus, as long as there is no fraud, comingling of business/personal assets, and all LLC operating procedures are followed, creditors cannot go after your personal assets/property.
Taxes. You can choose how you want to be taxed! In New Jersey LLCs are automatically taxed as a pass through entity (disregarded if one member, partnership if more than 1 member), but you can also opt to be taxed as an S-corporation or a C-corporation. A drawback to pass through taxation is that the members pay self-employment taxes and must pay self-employment tax payments to Medicare and Social Security.
Should I have my LLC taxed as an S-Corp? Maybe… the benefit is that you can pay yourself a reasonable salary (taxed at an income tax level) and then make distributions (dividends are usually taxed at a lesser tax rate), and possibly reduce your overall taxes.
Formation Costs. Relatively cheap to form ($125 in NJ) and operate going forward ($75 annual fee to State of New Jersey).
Operational Flexibility. LLCs do not have shareholders but instead have members. Further, there is no stock in an LLC, only membership units or membership percentages. There is no limit on the number of members that you may have, and even non-US citizens can be members of an LLC.
The flexibility of operations is limited only by your imagination (and legality). The governing document that outlines the operations, duties, and responsibilities of the LLC (and its members) is the Operating Agreement. If you are the sole member of a New Jersey LLC you are not even required to have an Operating Agreement (but a bank or other lender will ask for one if you need a loan or are selling your business).
Control. You can structure control as you see fit, as long as you properly record same in the Operating Agreement. (What the Operating Agreement says governs.)
Raising Money. As previously mentioned, professional money investors will not invest in a New Jersey LLC, however there is nothing that prevents small and medium sized investors (including friends and family) from investing in an LLC. Further, there are additional larger capital raising options that are open to LLCs such as debt/bond offerings, Private Placements (506(b) and 506(c) raises), passive capital investors, and other non-public offerings.
C-Corporations.
C-Corporations are formed by filing the Articles of Incorporation (which is like the company’s birth certificate) with the Secretary of State of New Jersey. Then an EIN number is obtained from the IRS for the C-Corporation. Finally, the corporation is registered with the State for tax purposes.
Overall, C-Corporations should be utilized only in certain circumstances (primarily where the company will eventually go public or raise professional capital). C-Corporations offer liability protection, but require double taxation (unless S-Corporation status is elected), are more expensive to operate (compared to LLCs because of the extensive record keeping regulations) and are the least flexible entities to operate. More specifically:
Liability. C-Corporations offer limited liability protection, but as previously mentioned there can be no fraud, comingling of business/personal assets, and all corporate operating procedures must be followed.
Taxes. C-Corporations are taxed as separate entities and thus there is double taxation unless S-Corporation status is elected.
Formation Costs. Much more expensive in both initial setup costs and ongoing operating costs.
Operational Flexibility. Much less flexible vs LLC and LOTS of record keeping requirements. This includes strict rules on adopting corporate bylaws, keeping corporate meeting minutes, shareholder meeting requirements, and strict rules regarding issuing stock.
Control. Because of the extensive operating requirements control is much more complicated and siloed. Generally speaking, the Board of Directors makes the most important decisions and hires officers and then the officers control the day to day operations and hiring and firing of employees.
Raising Money. Here is where the C-Corporation shines… It is the most favored entity choice for an initial public offering (going public), selling shares on a public stock exchange, or raising money from professional investors such as venture capitalists.
S-Corporations.
When discussing the LLC vs S-Corp the first issue that needs to be understood is that S-Corporation is an election (and not a separate entity). What this means is that to form an S-Corporation, first a lawyer forms the C-Corporation and then files additional documentation (IRS Form 2553 Election by a Small Business Corporation) to elect S-Corporation status.
Liability. In terms of liability, the debate between the LLC vs S-Corp vs the C-Corp there are no major differences in liability protection. They all protect you so long as you follow operating rules.
Taxes. Pass through taxation. All corporate income, losses, deductions, and credits flow to the S-Corporation’s shareholders.
Formation Costs. Much more difficult to form and thus more expensive.
Operational Flexibility. In terms of flexibility considering the LLC vs S-Corp… The S-Corp is much less flexible vs the LLC.
Control. Many restrictions on what you can do: Shareholders can only be individuals, trusts, and estates, and cannot be partnerships, LLCs, corporations or non-resident aliens. Further, there is a limit of 100 shareholders, and only one class of stock is permitted.
Raising Money. It is possible to revoke S-Corporation election and go back to being classified as a C-Corporation, and thus after revocation you have the availability of public raises, professional money, and IPO.
Other Entities.
There are other entities which are not utilized as often, and we will discuss in other articles:
Sole Proprietorship/Partnership: Operating a business under your own name (unwise). No liability protection, profits taxed on your personal tax return and no ability to raise professional money.
General Partnership/Limited Partnership: These were utilized extensively before LLCs and S-Corporations were created. Except for certain extreme circumstances, only utilized by entities that were formed before LLCs/S-Corporations were created, and certain private equity/finance deals that still utilize these entity forms because that is what they have always used in the past and are comfortable with same.
Non-Profit Corporations: For certain business purposes and activities (generally charitable in nature), a Non-Profit Corporation can be formed. There are no shareholders in a Non-Profit and no dividends can be distributed (only salaries). Formation is both expensive and time consuming, but the benefit is that taxes can be significantly reduced and possibly fully eliminated for the Non-Profit.
Conclusion.
In conclusion in selecting the LLC vs S-Corp vs C-Corp, you first have to understand your end goal and business activities:
-If you want to be the next Facebook, start a Delaware C-Corporation.
-If you are a NJ resident and you want to start a small website design or other non-tech consulting company (that will not seek professional money), a New Jersey LLC is probably the best choice for you.
-If you want to take advantage of certain tax benefits, consider starting a New Jersey LLC and elect S-Corp taxation, so that you can pay yourself a salary and take the rest in dividends at a lower tax rate.
-If you are in the 5 major boroughs of NYC then perhaps a NY S-Corp is the best choice (so that you avoid the LLC notice fees).
