Perpetual debate about the tax entities (Sole Proprietorship, LLC, C Corp, S Corp)

Even though there’s so much information out there (blogs, articles, books, references, discussion forums) to help people choose from different legal entities, it’s a difficult decision and it ultimately comes down to their personal situation and preferences.

 

I’ll simplify the different options and their impact:

 

• Sole Proprietorship : Simplest and Easiest. No forms needed except any filings with your state government like WA State needs you to acquire a Master Business License from the Business and Occupation (B&O) department. There’s no other paper work needed and no other administrative requirements except some accounting and reporting requirements from the tax filing perspective. You have all the control over how it functions, but the liability is all personal and similarly the taxes also flow to you and the individual needs to file a Schedule C for the sole prop taxes. You are also required to pay the self employment taxes which is a bummer.
• LLC : Little bit more complicated and time-consuming as it has more filing requirements. Similar to Sole Prop, the income is passed to the members of the LLC but the liability is not with the members, and hence the name Limited Liability Company. Participating members can choose the management aspects and the member salary is subject to self employment taxes. For partnerships LLCs, you’d need to file 1065 and K-1 forms.
• C Corp : More paperwork for filing and needs election of BoD (board of directors), and officers of the company. Also requires share distribution, annual meetings with MoMs (minutes of the meetings registered), stock holder meetings and annual report filings. Since the corporation is taxed at corp rate and the dividends are taxable for individuals, there is a possibility of double taxation. No corporation self employment tax but the salaries are subjected to self employment tax.
• S Corp :  Similar to C Corp, except that the income is passed directly to individuals involved. The income can be split as salary and distribution and the salary is subject to self employment taxes. S corp eliminates double taxation

Few notes about LLC:

• 1 member LLC can also be a Disregarded Entity
• Multi member LLC cannot be a Disregarded Entity and pays taxes as a partnership. The partnership files 1065 which generates a K-1 for each member. The K-1 is filed with individuals's 1040. In this case LLC acts as a pass-thru.
• When LLC needs to taxed as a corporation, they would file 8832 for Entity Classification Election
• LLC as a corporation : help on Pub 542 / 587