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Q: Incorporating ( Answered 5 out of 5 stars,   1 Comment )
Subject: Incorporating
Category: Business and Money > Small Businesses
Asked by: dabrown5-ga
List Price: $50.00
Posted: 18 Sep 2006 16:46 PDT
Expires: 18 Oct 2006 16:46 PDT
Question ID: 766396
LLC or C-Corp or S-Corp? My wife and I have purchased a tutoring
busines. We inherit several tutors who we will pay as private
contractors whom we will give 1099 forms to at tax time. The business
is already fairly profitable. Along with this business my wife and I
are also teachers with a combined income of approx. $115,000 year. We
own a home, have three children two in high school, one in college.
Which "corporation" structure is best for us?

Request for Question Clarification by denco-ga on 18 Sep 2006 17:09 PDT
Howdy dabrown5-ga,

Do you plan on, or at least are not opposed to your children working for the
business in some capacity?  Thanks!

Looking Forward, denco-ga - Google Answers Researcher
Subject: Re: Incorporating
Answered By: keystroke-ga on 18 Sep 2006 21:23 PDT
Rated:5 out of 5 stars
Hi dabrown5,

There are many factors which contribute to which kind of corporation
would work best for you.

Do you want the business to maintain separate accounts and file a
separate tax return for the business? If so, a C-corp is the only one
of these options that keeps the business totally separate from your

Do you want the least amount of paperwork possible? If so, an LLC might be for you.

Do you want to be able to give your employees (or yourself) generous
tax-deductible benefits such as life insurance and health insurance? 
A C-corp offers this option due to its separate-accounts nature.

Do you want flexibility to be able to change the business to something
else later? An S- or C-corp can be easily interchanged at a later
date. An LLC cannot.

Do you want the business to pass on to your children at your death? An
S- or C-corp would probably be best for these purposes.


Advantages of LLC:

-- Flexibility

An LLC's business is treated as personal income of the owners, but at
tax time, one can file the business' return on their own personal tax
return or choose to have it treated as either an S-corp or C-corp

"Further, an LLC with more than one owner is treated as a partnership
by default, but a multiple owner LLC can also elect to be treated as a
C corporation or as an S corporation. To elect C corporation
treatment, an LLC files a Form 8832 with the IRS. To elect S
corporation treatment, an LLC files a form 2553 with the IRS.

Another reason that a business might choose to be organized as an LLC
is to exploit the tax classification flexibility that LLCs allow. A
new business experiencing losses might choose to operate as a sole
proprietorship or partnership in order to pass through those losses to
the owners. A slightly more established business might operate as an S
corporation to save on self-employment taxes. A large mature business
with many owners might operate as a C corporation."

-- Avoiding double taxation

"One reason that a business might choose to be organized as an LLC is
to avoid "double taxation". A traditional corporation is taxed on its
income, and then when the profits are distributed to the owners of the
corporation (i.e., the shareholders), those dividends are also taxed.
With an LLC, income of the LLC is not taxed, but each owner of the LLC
(i.e., each member) is taxed based on its pro rata allocable portion
of the LLC's taxable income, regardless of whether any distributions
to the members are made. This single level of taxation can lead to
significant savings over the corporate form."

-- Deduction of losses allowed on tax forms.

--No requirement of an annual general meeting for shareholders (in
some states, such as Tennessee and Minnesota, it is in fact required,

--less paperwork and bookkeeping requirements than a corporation.

--Limited liability-- the owners are protected from the losses of the company


Disadvantages of the LLC

--It dissolves upon the member's deaths.

This could be a problem for you if you want to pass it onto your
children with the least amount of hassle.

--Many states have now instituted a "franchise tax" on LLCs which can
vary greatly and is basically a charge for the limited liability of
the company. (The franchise tax is often charged to companies that are
S-corps and C-corps as well.)

--self-employment tax of about 15 percent on the entire net income of
the business in many states

--difficult to change to a corporation later on if you so desire

-- you can't benefit from the company-funded, possibly tax-deductible
benefits that corporations would allow you to have (for you or for
your employees)


Advantages of S-corp and C-corp
(differenced discussed later)

--it will exist beyond your death

--You have limited liability just as with an LLC

--it is easy to switch back and forth between them at a later time if
you feel you made a wrong decision-- you simply check or uncheck a box


--you must hold yearly meetings and document them (AKA more paperwork)

--It allows the owners to hire themselves as an employee (for
instance, as president) and then participate in company funded
employee benefit plans like medical insurance and retirement plans.


Differences between S and C

-- An S-corp counts the profits as personal income for tax return
purposes, whereas a C-corp maintains separate accounts


Advantages of S-corp over C

--profits counted as personal income for tax purposes-- you might pay
less tax this way

--easier to have an "exit strategy" to shut down the business without
being double-taxed

--you won't have to deal with "double taxation" issues at all (there
is a way to not deal with this with a C-corp, however, see below)


Advantages of C-corp over S

--ability to give generous benefits to employees and have those taken
off profits on taxes as deductions

--rules are simpler than S-corp rules

--profits from business that would be double-taxed can be spent as
salaries to employees (including owners) and thus not counted as
profit. This way, the company can have even zero profit at the end of
the year to be taxed.


Both S-corps and
C-corps are required to hold meetings every year and keep records of
those meetings; an LLC does not require this. An LLC is also meant for
temporary purposes and is usually required to specify a date upon
which it will cease existence on its initial filing papers (and upon
the death of one of the partners).

LLCs are more desirable than sole proprietorships for those who are
running their businesses alone, because they do not hold the owner
responsible for the personal debts of the business as a sole
proprietorship would.

An LLC would funnel the funds to your
personal bank account, possibly putting you in a higher tax bracket
than you would want to be in, but saving you the double taxation of a
C-corp.  However, the LLC also comes with its own tax pitfalls:

"The owner of an LLC is considered to be self-employed and, as such,
must pay a ?self-employment tax? of 15.3% which goes toward social
security and Medicare. The entire net income of the business is
subject to self-employment tax.

The self-employment tax rate consists of two parts: 12.4% for social
security and 2.9% for Medicare. In 2006, only the first $94,200 of
total net income is subject to the social security portion of the tax.
All of the the total net income is subject to the Medicare portion of
the tax."

An S-corp and C-corp are similar in some ways, with a few very
important tax differences.
"1. An S Corporation is simply a C Corporation (also known as a
standard business corporation) that files IRS form 2553 to elect a
special tax status with the IRS. The articles of incorporation that
are filed with the state are same whether a corporation is a C
Corporation or S Corporation.

2. They both are separate legal entities that are created by a state filing.
Both offer the same limited liability protection, the owners are
typically not personally responsible for the debts and liabilities of
the business.

3. Both entities are required to follow the same formalities. They
must hold annual meetings of shareholders and directors each year and
meeting minutes must be kept with the corporate records."

However, an S-corp requires that the corporation's taxes and profits
are reflected in the personal income tax returns of the owners,
whereas a C-corp requires separate filings for the business and for
the owners. However, the C-corp can result in double taxation for
dividends paid from the business to the owners-- the business is taxed
on the profit, and the owners taxed on the dividends as income.



Incorporation as a C-corp would be highly desirable if it were not for
one factor: double taxation.  In a C-corp, the business is taxed both
on its profits and the owners taxed on those profits as personal
income, resulting in a double taxation for the owners. This may not be
a severe problem for you, however, and I highly recommend the C-corp
to businesses with employees. There are ways to avoid the double

If you use your dividends from the business to put money
back into the business, you may not be taxed on them as dividends:
"The double tax may not be a problem if: profits are to be 'plowed
back' into the business and not distributed to shareholders."

In fact, the double taxation issue might not even be an issue for you
if you until you want to "cash out" the business-- mete out the
profits that it has acquired.

"The C Corp status gives you a little more flexibility in terms of tax
deductibility of benefits to officers, and the tax rate is lower if you
are building up working capital.  The S Corp eliminates double taxation
when you want to cash out, and is supposed to be a little simpler (e.g.,
less expensive) on the paperwork."

Another advantage to filing as a C-corp is that if and when your
partner ever leaves the business and you should want to convert to an
S-corp, the process is simple.
"converting an S-Corp to a C-Corp [or vice-versa] is simply a "check
the box tax election? (or - actually ? ?unchecking the box?) - this
can be done in a day with a single tax form.  No lawyers, no
accountants, no money.  Therefore, while the LLC has some benefits,
the costs of converting the LLC into a fundable entity is
substantially higher and usually not worth the additional effort."

If you're willing to funnel the business' profits through your own
accounts, the LLC does have some good advantages over a C-corp.
With an LLC, you could split the profits however you would want
between your partner and yourself. With a corporation, you might be
more stifled in how you could distribute the profits. If you live in
Texas, an LLC does not have to pay franchise tax, a 4.5 percent tax on
corporations otherwise.

However, in some states such as California, the LLC is taxed on "net
income," instead of gross profits, such as an S-corp would. (The tax
rate in California is much more lenient with S-corps than C-corps,

Some further thoughts on the taxation of C-corps:

"> '5). Many say that C-corp will end up paying double tax when you start
> wanting to pay out the profit from the corporation. So what's the end
> of the story of a C-corp? What's the common exit strategy for an
> ordinary C-corp?'

There is no general exit strategy that I know of except to pay tax on
the income twice.  A C corporation's net income is taxed at the
corporate level.  When it is distributed to the stockholders in the
form of dividends, it is taxed to them as ordinary income.  If a C
corporation sells appreciated property, the gain is taxed at the
corporate level and again when (and if) it is distributed to the
stockholders in the form of dividends.

If a C corporation distributes appreciated property to its
stockholders, it must recognize and pay tax on the gain as if it had
sold the property at its fair market value (IRC Sec. 311(b)), and the
stockholders recognize the FMV of the property as dividend income to
the extent of the corporation's earnings and profits (IRC Sec. 316).
If there is not enough E&P to support the dividend, the distribution
reduces the stockholder's basis in the corporation's stock (thus
increasing the gain to be recognized on ultimate sale of the stock or
liquidation of the corporation).  Any excess of the distribution over
the stockholder's basis is capital gain to the stockholder.

If a C corporation liquidates and distributes all of its assets to its
stockholders, it must recognize gain at the corporate level as if it
had sold the assets at FMV.  In that case, the stockholders will
recognize capital gain to the extent that the FMV of the assets
distributed in liquidation exceeds their basis in the corporation's
stock.   Since the 1986 repeal of the one-year liquidation rules, it is
just about impossible to get appreciated assets out of a C corporation
without paying tax on the gain twice.  That fact accounts for a great
deal of the increase in use of flowthrough entities such as
partnerships, S corporations and LLCs in the last 20 years.

That being said, many personal service businesses are organized as C
corporations because (a) the C corp rules are simpler than the S rules,
(b) they can effectively zero out their net income by paying a salary
to the stockholder/employee, so there is no net income to be taxed at
the corporate level, and (c) they do not own any real estate,
inventory, or other assets that are likely to increase in value."

In essence, by paying yourself and your partner a salary equivalent to
the profits that the company would make, you can show that the company
does not make a profit and then you will only be taxed on these
profits once. 

It is also easier, within a C corporation, to give large
tax-deductible benefits to owners/employees, such as life and health
insurance. It is not as easy or possible for owners of S-corps or LLCs
to do this, because of the "pass-through" nature of those
incorporations (the funds go through your bank account first.)



Search terms:
(on Google and Google Groups)
llc limited liability protection
llc s corp c corp

I hope this information is helpful for deciding which corporation
structure is best for you. If you would like to answer the questions
that I posed at the beginning of my answer, I will then tell you what
type of corporation would suit your most important needs.  If you need
any additional help or clarification, let me know and I'll be glad to


Request for Answer Clarification by dabrown5-ga on 21 Sep 2006 07:52 PDT
thanks very much for the thourough answer. I especially like the idea
of simply taking a salary from the business to avoid the "double
taxation" issue. Two questions of clarification. 1) When it comes to
the dreaded "paperwork" i.e. meetings with minutes, shareholders
etc... is there a way of simplifying this process that satisfies the
state's need for paperwork. The issuing of stock also makes me nervous
when it comes to C-corp. It's just my wife and I. We don't have
"shareholders." 2) How effective are the on-line services for
incorporation. Obviously we need to sit down with a CPA to investigate
the tax ramifications for us. thanks again.

Clarification of Answer by keystroke-ga on 21 Sep 2006 11:42 PDT
Hello dabrown5,

I'm glad that my answer could help you. As far as your questions go:

1. Many sources agree that in fact, with regulations these days, the
idea that the LLC is much less paperwork is an old one. The LLC does
not have the requirement of an annual shareholder meeting, but it has
a lot of paperwork that comes with it, also. You will have to do a lot
of paperwork no matter what! If you're a teacher, though, you're
probably used to this. Anyway, the shareholder's meetings, I would
assume, for your business would be pretty simple affairs: you and your
wife sitting and talking about the business and taking notes of what
you talk about and for how long (the minutes). There will be paperwork
involved, but I don't foresee the paperwork involving the
shareholder's meetings to be hugely difficult for you to complete
since it is just the two of you. You should ask your CPA and/or lawyer
this, however, to find out what the requirements are in your state.

The "shareholders" in this case are you and your wife. You own 100% of
the stock in the company. You're obviously not required to create more
stock and raise funds that way, but that option would be open to you
as it is to any business if you choose to do so at a later date. Any
time in my answer or in online or official resources when the
"shareholders" and "stock" and "dividends" are mentioned, that is
referring to the owners (you and your wife), your ownership of the
company and the dividends, or profits, that get paid back to you at
the end of the year. It is a bit confusing at first but it gets
simpler once you hear the jargon more often. You are definitely not
required to issue stock or anything like that.

In a previous Google Answer I completed:

I talked about and how it could be useful to help
incorporate. I personally have no knowledge of online incorporation
services and whether they're useful or not, but since they are
relatively inexpensive compared to an attorney and some of them carry
guarantees of their work, it might be a good idea to look into what
they have to offer. If you do decide to work with a company like, I would contact them and ask for references and at
least get an idea of what the process is like and what it includes.

Since you do have a company that is already established, with
employees, I would make sure to talk to a CPA or business attorney no
matter what. Especially with employees involved, there are bound to be
issues of tax law that I'm not aware of or that only apply to your
state. It really is worth it in the long run to spend a little time
doing it the right way, rather than regretting it later. Make sure
your CPA is VERY well-qualified and highly recommended.

Let me know if you need any more information!

dabrown5-ga rated this answer:5 out of 5 stars
Thanks very much for all your work.

Subject: Re: Incorporating
From: keystroke-ga on 22 Sep 2006 06:03 PDT
Thank you for the five stars, dabrown! Good luck :)

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