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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