Latest / The Cynical CPA / C-Corps, and S-Corps and LLCs, Oh My!
Transcript
- Corrine Hasbany: Welcome to The Cynical CPA, the podcast where accounting meets real life and we keep it blunt, honest with zero sugarcoating. I'm your host, Corrine Hasbany CPA, Enrolled Agent and founder of XAct Accounting Services. Each episode, we cut through the accounting jargon, tax confusion and bookkeeping chaos and tell you what actually matters. No fluff, no spin, just real talk, real numbers and the truth you wish your accountant told you sooner. Let's get into it. Welcome back to the Cynical CPA, the podcast where we talk about accounting, taxes, and everything in between. I'm Corrine Hasbany, CPA and Enrolled Agent, and today we're talking about three combinations of letters that seem to cause a lot of confusion: C Corp, S-Corp, and LLC. And I get why. You hear one person say, you need an LLC. Someone else says, No, you need to be an S-Corp. And then somebody on social media tells you that you've been doing everything wrong for the last three years. So let's take a breath. We're going to break this down. What is an LLC? What is an S Corp? What is a C Corp? And what do they actually mean? And what is the difference between your legal structure and your tax treatment? Because those are two different things. And once you understand that, the whole conversation gets a lot less confusing. But before we jump into today's topic, a quick note to remember. The Cynical CPA is here to talk about accounting and tax topics in a way that's easy to understand. But this podcast is for general, educational, and informational purposes only. Tax rules and accounting treatment vary depending on your circumstances. So nothing you hear should be considered personal tax or accounting advice. If you have a specific situation, talk to your accounting and tax professional. Now let's talk C Corps, S Corps, and LLCs. Oh my. Let's start with the LLC because that's usually where people begin. An LLC is a legal business structure. It's usually created under state law and generally speaking provides a separation between the business and its owners. But here's the important part forming an LLC doesn't automatically tell the IRS how you're going to be taxed. And that's where people get a bit confused. If you're the only owner of an LLC, the default federal tax treatment is generally referred to as a disregarded entity. What does that mean? Well, it means the IRS ignores the LLC structure for income tax purposes. The business profits and losses pass through directly to your personal tax return and are reported on a Schedule C, which I then include with your federal tax form 1040. If your LLC has multiple owners, the IRS automatically treats the business as a partnership for federal tax purposes. And an eligible LLC Can elect to be taxed as a C corporation or an S corporation. And just a note here: making a corporate tax election does not change your legal structure. You remain an LLC under state law and keep the legal liability protections. You are simply asking the IRS to apply corporate tax rules to your business earnings. So when someone says, I'm an LLC, that actually doesn't tell me everything I need to know about how the business is taxed. Think of it this way: LLC equals legal structure, S Corp or C Corp equals tax treatment. Different questions. And that's probably the biggest point I want you to take away from this episode. Now let's talk about the C Corp. A C corporation is generally a separate taxpayer. The corporation files its own federal income tax return on a form called an 1120. The corporation has income, it has expenses, it calculates its taxable income. And the corporation pays tax on that taxable income. Then, if the corporation distributes some of its after-tax profits to shareholders as dividends, those dividends can be taxable to the shareholders. And that's where you hear the term double taxation. The income can be taxed at the corporate level, and then the dividend can be taxed again to the shareholder. Now that doesn't mean C corps are bad. There are legitimate reasons businesses use them. For example, Some businesses may want to retain and reinvest profits, bring in investors, or operate with a corporate structure for particular business reasons. But this isn't a case of C Corp equals big company, therefore everybody needs one. That's not how it works. And it's also not automatically the right fit or the wrong fit for every business. It depends on the business and what the owners are trying to accomplish. Now we get to the one everybody's excited about the S-Corp. An S-Corp isn't necessarily a separate legal entity you create. It's a tax election. And this is the part I really want you to remember. Your LLC can elect to be taxed as an S-Corp. So you don't necessarily have to change the legal structure of your business. You're changing how the IRS treats it for tax purposes. But here's another important distinction. The S-Corp files its own separate federal tax return. The business generally files Form 1120-S, reporting its income, expenses, profits, and losses. But the S Corp generally doesn't pay federal income tax at the corporate level like a C Corp does. Instead, the income or loss generally passes through to the shareholders and it is reported on their personal tax returns. So, the business files its own return, but the income or loss flows through to the owners which are known as shareholders. That's why an S Corp is called a pass-through entity. So yes, you can have an LLC that's taxed as an S Corp, and that S Corp files its own tax return. And the resulting income or loss generally passes through to the owner's personal return. Now, one of the things that makes an S Corp taxation different is how the owner or the shareholders are compensated. There can be wages and distributions, and they are not treated the same way for tax purposes. The wages are subject to payroll taxes, while qualifying S Corp distributions generally are not subject to self employment tax. Sounds simple, right? Well, there are rules. If you're working in your S Corp, you need to pay yourself reasonable compensation for the services you're providing. And reasonable doesn't mean what's the smallest salary I can pay myself. That's not the spirit of the rule. Reasonable compensation takes into account the work you're actually performing and the circumstances of the business. If you're running the company, doing the sales, managing the customers, doing the work, and basically wearing every hat in the building, paying yourself a tiny salary is something that needs to be looked at very carefully. And this is where those social media videos that say, just become an S-corp and pay yourself $20,000, leave out a few important details. There's a little bit more to it than that. An S-Corp isn't just check a box and magically everything is better. There are additional responsibilities. You have payroll, payroll tax filings, a separate business tax return, possibly additional bookkeeping and record keeping. And when you're considering S-Corp taxation, you're not looking at one number. You're looking at the whole picture, the tax treatment, the payroll requirements, the additional filing requirements, the administrative work. And whether that structure actually makes sense for your particular business. And that's where your CPA or tax professional can look at your specific circumstances and run the numbers, because there isn't one answer that applies to every business. So, which one is right? And this is where I'm going to disappoint anyone looking for a magic answer. There isn't one. If you're just starting a business, your situation is going to be different from someone who's been operating for years. If your business has moderate profit, that's different from a business with significant and consistent profit. If you're the only owner, that's different from having multiple shareholders. If you're planning to bring in investors, that's another consideration. If you're actively working in the business, that's another piece of the puzzle. There are a lot of moving parts. So instead of asking, should I be an LLC or an S Corp, a better question is how is my business currently structured? How is it currently taxed? Does that still make sense for my situation? That's a much more useful conversation. So here are three points to remember about LLCs, S Corps, and C Corps. Number one, an LLC is a legal structure. It does not automatically determine your tax treatment. Number two, an S Corp is a tax election. An eligible LLC can elect to be taxed as an S corporation. Number three, the S Corp files its own tax return. But its income or loss generally passes through to the shareholder's personal return. A C Corp is generally a separate taxpayer, and its profits and distributions can result in taxation at both the corporate and shareholder levels. And here's today's cynical CPA reality check. Don't form an LLC because somebody told you that you need to have an LLC. Don't elect S-Corp status because somebody on TikTok said everyone making a certain amount of money needs to elect S-Corp status. And don't choose a C-Corp because it sounds more official. Your business isn't a personality test. Look at the actual business, look at how it's structured, look at how it's currently being taxed, and look at the administrative requirements and understand what you're choosing. Because changing your business structure or tax treatment is not something you want to stumble into because somebody made a 30-second video. And remember, there's a lot more to the decision than just the name on the paperwork. It's about how that structure affects the way your business operates, how you report your income, what additional requirements you may have, and what makes sense for the business you actually have. So before you make a change, make sure you understand what you're changing, why you're changing it, and what comes with that change. Because when it comes to your business, I saw it on TikTok, probably shouldn't be part of your tax strategy. So there you have it, C Corps and S Corps and LLCs and all the things that can make choosing a business structure feel a little like you're walking down the yellow brick road. It's important to understand that there isn't one magic answer that works for every business. Your circumstances matter, and that's where having a conversation with your accountant and tax professional can make a difference. Because your business is your business, your numbers are your numbers. And just because your cousin's business is an S Corp, Or somebody on TikTok says just be an S Corp doesn't mean that's the right answer for you. So before you follow the advice of the person on Instagram, take a breath and look at the whole picture. Because when it comes to taxes, going with but somebody on the internet says is probably not the best place to start. So thanks for listening to the Cynical CPA. I'm Corrine Hasbany, CPA and Enrolled Agent. Until next time, keep your books balanced, understand your numbers, and make decisions based on what Actually makes sense for your business. Thanks for listening to The Cynical CPA. If you liked what you heard, make sure to follow for more real talk about accounting, taxes, and everything in between. No fluff, no sugarcoating, just straight talk and clarity because someone has to say what your accountant is really thinking. Until next time, remember numbers don't lie, but they do need a translator. And that's where The Cynical CPA comes in. If you're ready to stop guessing and start gaining clarity in your numbers, head to xactaccountingservices.com and click on Let's Connect.