Which Business Entity Should You Choose? S-Corp, C-Corp, LLC? | 791
“Choosing the right structure is about where you want to go, not just where you are today.” - Harry Cendrowski
1. S-Corp: Overhyped and Often Misunderstood
- Many business owners default to an S-Corp to save on FICA (payroll) taxes.
- This choice can be short-sighted, especially if the owner has not considered long-term growth, financing, or investment plans.
- Major downside: No tax basis for debt at the shareholder level, limiting deductions if the business borrows money.
2. LLC Taxed as a Partnership: More Flexibility
- Preferred by private equity investors and professional investors because:
- They can’t invest in S-Corps (due to shareholder restrictions).
- LLCs allow multiple financing rounds (Series A, B, C, D) and different classes of ownership, unlike S-Corps which can only have one class of stock.
- Offers options like carried interest and profit interests, which are not available in S-Corps.
- Easier to plan for growth, investor entry, and partial ownership sales.
3. C-Corp: Strategic for Certain Growth Plans
- Often used when:
- A company may qualify for Qualified Small Business Stock (QSBS) exemptions.
- The business has high working capital needs and benefits from the 21% corporate tax rate (better for reinvesting profits).
- Sometimes elected by LLCs for C-Corp tax treatment when appropriate.
When Should You Change Entity Types?
- Plan based on your 2 to 5-year horizon:
- Are you raising capital?
- Do you plan to sell?
- Are you acquiring other businesses?
- If you're already an S-Corp but want flexibility, set up a new LLC and transfer the assets via an F-reorganization.
- Act before the event happens, not when you're in the middle of a transaction.
Additional Critical Points
- Reasonable Salary Requirement for S-Corps:
- S-Corp owners must pay themselves a reasonable salary before taking distributions to avoid IRS penalties.
- Undervaluing your salary can lead to tax issues and lower your business valuation at exit (buyers will normalize your compensation in their calculations).
- State Tax Risks (SALT - State and Local Taxes):
- Many business owners underestimate exposure to state taxes.
- States are aggressive about taxing services and products sold into their jurisdiction, even remotely.
The Big Picture: Don’t Let Your Structure Limit Your Growth
- The wrong entity choice can:
- Block investors.
- Restrict financing flexibility.
- Increase tax exposure.
- Lower your business valuation.
- Choosing the right structure is about where you want to go, not just where you are today.
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