2 posts tagged with "business structure"

Choosing the right business entity is one of the most critical decisions a founder makes. It impacts your taxes, your ability to raise money, and your administrative workload. Two of the most common structures for incorporated businesses are the C corporation and the S corporation. What’s the difference, and which one is right for you?

TL;DR​

C corporations are taxed at the corporate level, and shareholders are taxed again when they receive dividends—a system known as double taxation. S corporations are "pass-through" entities, meaning profits are taxed just once on the owners’ personal tax returns, but they come with strict ownership limits. If you plan to reinvest heavily and raise venture capital, the C corp is often the cleaner, more scalable choice. If you're a profitable, owner-operated business and want to distribute cash while paying yourself a reasonable salary, an S corp can significantly lower your tax bill.

Either way, Beancount.io is built to keep your books clean with plain-text, auditable entries and export-ready financials that make tax time a breeze.

Quick Comparison​

Note: The federal corporate income tax is a flat 21%. However, state rules for both C corps and S corps vary widely. Always verify the tax treatment in your state of incorporation and operation.

What is a C Corporation?​

A C corporation is the standard, default corporate structure in the United States. When you file articles of incorporation with a state, you create a C corp unless you elect otherwise. This structure provides limited liability protection for its owners (shareholders), requires formal governance (a board of directors, officers, bylaws), and creates a legal entity that investors and banks recognize and understand.

How C Corps Are Taxed​

C corps have a distinct tax identity. They file their own corporate tax return, IRS Form 1120, and pay taxes on their net income at the corporate level. If the corporation then distributes its after-tax profits to shareholders in the form of dividends, those shareholders must report that dividend income on their personal tax returns and pay taxes on it again. This is the "double taxation" C corps are known for.

Why Choose a C Corp?​

• Fundraising & Equity: This is the biggest draw for startups. C corps can issue multiple classes of stock (e.g., common and preferred), which is essential for venture capital deals. Structuring option pools, SAFEs, and convertible notes is straightforward.
• Reinvestment: If you plan to plow all your profits back into growing the business, you can avoid the second layer of tax by simply not paying dividends. The profits are taxed once at the corporate rate and remain in the company.
• Signaling: For better or worse, incorporating as a Delaware C corp signals to investors that you intend to build a venture-scale company.

Drawbacks of a C Corp​

• Double Taxation: The primary disadvantage. If you plan to distribute profits regularly, you’ll pay tax twice on the same dollar.
• Administrative Burden: C corps come with more compliance requirements, including holding board meetings, maintaining corporate minutes, and handling more complex state and federal filings.
• Limited Deductions: Certain tax credits and deductions available to individuals or pass-through entities are not available at the corporate level.

What is an S Corporation?​

An S corporation is not a different type of legal entity but rather a special tax election made with the IRS. A domestic corporation (or an LLC that elects to be taxed as a corporation) can file to become an S corp, which allows it to be treated as a pass-through entity for federal tax purposes.

Eligibility Snapshot​

To qualify for and maintain S corp status, a company must meet strict criteria:

• Have no more than 100 shareholders.
• All shareholders must be U.S. individuals, certain trusts, or estates. No corporations, partnerships, or non-resident aliens can be shareholders.
• Have only one class of stock economically. (Differences in voting rights are allowed, but all shares must have the same rights to profits and assets).
• Not be an ineligible corporation, such as a bank or insurance company.
• You must file Form 2553 on time. For an existing business, this is generally by the 15th day of the third month of the tax year (March 15th for a calendar-year business).

Why Choose an S Corp?​

• Single Layer of Tax: Profits and losses "pass through" the business directly to the owners' personal tax returns, reported via a Schedule K-1. The corporation itself does not pay federal income tax.
• Self-Employment Tax Savings: This is a key benefit. Owner-employees must pay themselves a "reasonable salary," which is subject to FICA taxes (Social Security and Medicare). However, any additional profits can be paid out as distributions, which are not subject to self-employment taxes.

Drawbacks of an S Corp​

• Strict Rules: The ownership restrictions are rigid. Accidentally violating one (e.g., selling stock to an ineligible shareholder) can lead to an "inadvertent termination" of S corp status, which can have messy tax consequences.
• "Reasonable Compensation" Scrutiny: The IRS pays close attention to whether the salary paid to owner-employees is reasonable. Paying yourself an artificially low salary to maximize tax-free distributions is a major red flag for an audit.
• State Variability: Not all states recognize the S corp election. Some tax S corps as if they were C corps, or they may impose a separate entity-level tax, partially negating the federal tax benefit.

Which Should You Pick?​

The decision boils down to your goals for ownership, funding, and cash flow.

Consider a C corp if you expect to:

• Seek institutional investment from venture capitalists.
• Create different classes of stock for founders and investors (e.g., preferred shares).
• Use complex equity instruments like SAFEs or convertible notes.
• Have non-U.S. owners, either now or in the near future.
• Reinvest profits for several years before taking significant cash out of the business.

Consider an S corp if you:

• Are 100% owned by U.S. individuals who meet the criteria.
• Are already profitable and want to distribute cash to owners efficiently.
• Can confidently run payroll and pay owner-operators a defensible, market-rate salary.
• Do not need complex equity classes for different types of owners.

If you’re unsure, many businesses start as a Delaware C corp to maintain maximum flexibility. You can evaluate making an S corp election later if your profitability and ownership structure make it advantageous.

Beancount.io: How Your Books Differ (with Examples)​

Whether you choose a C or S corp, Beancount.io’s plain-text ledger makes the flow of money for taxes and equity explicit and auditable. Here are a few examples illustrating the key differences in your journal entries.

1) C Corp: Accruing and Paying Corporate Income Tax​

A C corp is responsible for its own income tax. You'll accrue this liability and then pay it.

2025-03-31 * "Accrue federal corporate income tax for Q1"
  Expenses:Taxes:Income            12500.00 USD
  Liabilities:Taxes:Federal       -12500.00 USD

2025-04-15 * "Pay Q1 2025 federal estimated tax"
  Liabilities:Taxes:Federal        12500.00 USD
  Assets:Bank:Checking            -12500.00 USD

2) C Corp: Paying a Dividend vs. Retaining Earnings​

When a C corp distributes profits, it's a dividend. This is a reduction of equity, not an expense.

2025-06-30 * "Board declares and pays cash dividend"
  Equity:Dividends                 50000.00 USD
  Assets:Bank:Checking            -50000.00 USD

If you retain the earnings instead, you simply don’t post this transaction. The profit stays in your Equity:RetainedEarnings account.

3) S Corp: Reasonable Salary & Payroll Taxes​

S corp owners must be paid a salary. This is a standard payroll expense, complete with employer-side taxes.

2025-01-31 * "Owner payroll (gross wages and employer taxes)"
  Expenses:Payroll:Wages            8000.00 USD  ; Gross salary
  Expenses:Payroll:EmployerFICA      612.00 USD  ; Employer portion of taxes
  Liabilities:Payroll:Federal       -2000.00 USD  ; Withholding + FICA
  Liabilities:Payroll:State           -400.00 USD  ; State withholding
  Assets:Bank:Checking              -6212.00 USD  ; Net pay to owner

2025-02-15 * "Remit payroll taxes to agencies"
  Liabilities:Payroll:Federal        2000.00 USD
  Liabilities:Payroll:State           400.00 USD
  Assets:Bank:Checking              -2400.00 USD

4) S Corp: Owner Distribution​

This is how profits beyond salary are paid out in an S corp. Notice it is not an expense. It's a direct draw from equity, similar to a dividend, but with different tax implications for the owner.

2025-03-15 * "Owner distribution (profit pass-through)"
  Equity:Distributions:OwnerA       20000.00 USD
  Assets:Bank:Checking             -20000.00 USD

The owner receives a Schedule K-1 detailing their share of the company's profit and handles the tax on their personal return.

Chart-of-Accounts Tips​

• Taxes:
  • C corp: You'll need Expenses:Taxes:Income and Liabilities:Taxes:Federal.
  • S corp: This income tax account is often unused at the federal level, but accounts for payroll taxes (Expenses:Payroll:Taxes and Liabilities:Payroll:*) are essential.
• Equity:
  • C corp: A standard setup includes Equity:CommonStock, Equity:AdditionalPaidInCapital, Equity:RetainedEarnings, and Equity:Dividends.
  • S corp: Your chart will look similar but often uses Equity:Distributions instead of dividends. Some track Equity:AAA (Accumulated Adjustments Account) to manage distribution basis.
• Payroll:
  • Both structures will need robust Expenses:Payroll:* and Liabilities:Payroll:* accounts if they have employees (including owner-employees).

Required IRS Forms (Common Cases)​

• C corp: Form 1120 (Annual Income Tax Return), Form 1120-W (Estimated Tax), Form 941 (Quarterly Payroll), Form 940 (Annual Unemployment/FUTA), Form 1099-DIV (for each shareholder receiving dividends), W-2/W-3.
• S corp: Form 1120-S (Annual Income Tax Return), Schedule K-1 (for each shareholder), Form 941/940, W-2/W-3.
• States: Remember that separate state income, franchise, and payroll tax returns will likely apply to both.

FAQ Quick Hits​

• Can an LLC be an S corp? Yes. An LLC can file Form 8832 to elect to be taxed as a corporation, and then file Form 2553 to elect S corp status (assuming it meets all eligibility rules).

• Is an S corp “always cheaper” for taxes? Not necessarily. The benefit depends entirely on your profit levels, the owner's reasonable salary, state tax laws, and the individual owner's tax bracket.

• Can S corps have preferred stock? No, not in an economic sense. S corps can only have one class of stock. You can have different voting rights (e.g., voting and non-voting common stock), but all shares must have identical rights to distributions and liquidation assets.

• Can I switch from one to the other later? Yes, but it can be complex. Converting from a C corp to an S corp is common, but you must be mindful of timing and potential built-in gains (BIG) tax rules. Converting from an S corp to a C corp is also possible and often required before a VC funding round.

How Beancount.io Helps​

No matter which entity you choose, Beancount.io provides the clarity and control you need.

• Plain-text, version-controlled books that scale from a single-owner S corp to a venture-backed C corp.
• Clear payroll and equity workflows that make it easy to distinguish distributions from dividends, track stock option expenses, and manage retained earnings.
• Clean exports for your CPA, including a trial balance, income statement, and balance sheet, with a fully auditable trail for every number.
• Powerful automations for bank feeds and document capture, without ever sacrificing the transparency of a human-readable ledger.

Want a head start? Ask for our sample C-corp and S-corp Beancount charts of accounts and example journal bundle.

*Disclaimer: This guide is for informational purposes only and does not constitute legal or tax advice. Tax laws and entity regulations vary by state and are subject to change. You should consult with a qualified CPA or attorney before choosing or changing your business entity type.*

Choosing a business structure is one of the first real “finance” decisions you’ll make. For most small teams and solo founders who want liability protection and pass-through taxation, the short list is usually an LLC or an S corporation.

This guide explains how they differ—legally, operationally, and on your tax return—and shows how to keep clean, audit-proof records for either structure in Beancount.io (plain-text, double-entry accounting that scales from freelancer to S corp).

At a Glance​

How They Actually Differ​

While both LLCs and S corps offer a crucial liability shield, their legal and financial mechanics are fundamentally different. Here’s a deeper look at what sets them apart.

Formation and Formalities​

A Limited Liability Company (LLC) is a legal entity created by state law. The process involves filing "articles of organization" with your state and adopting an "operating agreement," which is a flexible internal document that outlines how the business will be run and how profits will be split.

An S corporation, on the other hand, is not a legal entity itself but a tax election made with the IRS by filing Form 2553. This election can be applied to either a standard C corporation or an LLC. Once you elect S corp status, you must adhere to stricter corporate formalities, including drafting bylaws, appointing a board of directors and officers, holding annual meetings, and keeping detailed records of those meetings (known as "minutes").

Ownership & Investors​

Ownership flexibility is a hallmark of the LLC. You can have an unlimited number of owners (called "members"), including individuals, other corporations, and foreign citizens. The operating agreement allows for custom profit splits ("waterfalls") and different classes of membership, which is ideal for complex partnerships.

The S corp is far more restrictive. It can have no more than 100 owners (called "shareholders"), all of whom must be U.S. citizens or residents. Other entities (like corporations or partnerships) cannot be shareholders. Furthermore, S corps can only have one class of stock, meaning all shareholders have identical economic rights (profits and distributions must be allocated proportionally to ownership). This simplicity can make the cap table cleaner but severely limits who can invest.

Taxes & Filings​

By default, an LLC is a pass-through entity.

• A single-member LLC is a "disregarded entity," meaning its income and expenses are reported on a Schedule C filed with the owner’s personal Form 1040.
• A multi-member LLC files a partnership tax return, Form 1065, and issues a Schedule K-1 to each member detailing their share of the profit or loss.

An S corp is also a pass-through entity, but it files its own business tax return, Form 1120-S, and also issues K-1s to its shareholders. The key difference is that any owner who works for the company must be treated as an employee and paid a reasonable salary through a formal payroll system.

How Owners Get Paid​

This is one of the most significant distinctions. LLC members are not employees. They get paid by taking distributions (or "draws") of the company's profits. Members are responsible for paying their own income and self-employment taxes (Social Security and Medicare) on their entire share of the net profits, regardless of how much cash they actually took out.

S corp owner-employees face a two-part system.

1. Reasonable Salary: They must be paid a reasonable wage for the work they perform, which is subject to standard payroll taxes (FICA). The company pays the employer portion, and the employee pays their portion.
2. Distributions: Any remaining profits can be paid out as distributions, which are not subject to self-employment or FICA taxes. This potential tax saving is the primary reason businesses elect S corp status. The IRS requires the salary to be "reasonable," so you can't pay yourself $1 and take the rest in distributions; you must document how you determined the salary amount.

Transferability & Lifespan​

S corp stock functions like typical corporate shares. It is generally freely transferable (unless restricted by a shareholder agreement), and the corporation has a perpetual existence, meaning it continues even if a shareholder leaves or passes away.

Transferring ownership in an LLC is often more complex. The operating agreement dictates the rules, and it typically requires the consent of the other members to sell or transfer ownership units. This protects members from being forced into business with strangers but can make exiting the business more cumbersome.

Should You Elect S Corp Status for Your LLC?​

A very common path for successful small businesses is to start as an LLC and elect S corp taxation later. This "LLC now, S corp when profitable" strategy allows you to enjoy the simplicity of an LLC in the early stages and switch for tax optimization once your income grows.

Founders typically make the switch when:

• Profits are steady and significant. The amount paid in self-employment tax as an LLC member becomes greater than the FICA taxes on a reasonable salary plus the compliance costs of an S corp.
• They desire more structure. The formal requirements of an S corp can enforce better financial discipline and send a more "serious" signal to lenders or future investors.

Electing S corp status for your LLC brings concrete changes:

• You must set up and run payroll for all owner-employees.
• You must adhere to corporate record-keeping, including holding meetings and documenting them with minutes.
• Your annual tax preparation becomes more complex, requiring Form 1120-S and K-1s.

When is it better to remain an LLC?

• You need flexible ownership structures, like special profit allocations or having a corporation or foreign partner as a member.
• Your profit is volatile or you are still in the early stages. The overhead and cost of running payroll might not be worth it yet.
• You plan to issue complex equity, like token-based compensation or preferred units, that don't fit the S corp's "one class of stock" rule.

Practical Rule of Thumb: Before you switch, model your next 12 months of expected profit. Calculate your total tax burden (income + self-employment tax) as an LLC. Then, calculate your total tax burden as an S corp (income tax + FICA tax on a reasonable salary). If the savings from the S corp structure are clear, recurring, and outweigh the added compliance costs, the election is worth a serious look. Be sure to document your analysis for determining a "reasonable salary."

How to Keep Either Structure Clean in Beancount.io​

No matter which entity you choose, chaotic books can undermine your liability protection and create tax-time nightmares. Beancount.io gives you a plain-text, double-entry ledger with automated imports and tax-ready reports, so your legal structure doesn’t turn into bookkeeping sprawl.

Chart of Accounts Suggestions​

A clean chart of accounts is the foundation. Here are our recommendations:

• For an LLC:
  • Equity:Member-Capital (for initial and subsequent contributions)
  • Equity:Member-Distributions (for owner draws)
  • Standard Income and Expense accounts.
• For an S corp:
  • Equity:Common-Stock (for capital contributions)
  • Equity:Retained-Earnings (where profits accumulate)
  • Expenses:Payroll:Wages
  • Expenses:Payroll:EmployerTaxes
  • Equity:Shareholder-Distributions (for payments out of profit)

Example Entries​

Here’s how common owner payments look in a Beancount.io ledger.

LLC member distribution: This transaction records a $5,000 payment to a member, reducing cash and tracking the draw in a dedicated equity account.

2025-03-15 * "Member distribution"
  Assets:Bank:Checking             -5,000 USD
  Equity:Member-Distributions       5,000 USD

S corp owner salary (from a payroll run): This entry captures the gross wage, the employer's share of payroll taxes, and the total cash leaving the bank. Withholding liabilities would also be tracked here.

2025-03-31 * "Owner payroll"
  Expenses:Payroll:Wages            8,000 USD
  Expenses:Payroll:EmployerTaxes      612 USD
  Assets:Bank:Checking             -8,612 USD
  Liabilities:Payroll:Withholding     0 USD  ; Net pay + withholdings

S corp shareholder distribution: This is a simple transfer from cash to the shareholder distribution equity account, separate from payroll.

2025-04-10 * "Shareholder distribution"
  Assets:Bank:Checking            -10,000 USD
  Equity:Shareholder-Distributions  10,000 USD

Close the Loop at Tax Time​

With a clean Beancount.io ledger, tax season is streamlined:

• Generate your Profit & Loss and Balance Sheet statements directly from your transactions.
• Export the data your accountant needs for your specific tax form (Schedule C, 1065, or 1120-S).
• Keep your reasonable salary memos, meeting minutes, and other compliance documents alongside your transactions for a complete, audit-ready financial record.

When Each Choice Shines​

Here's the decision in a nutshell.

Choose (or remain) an LLC if you want:

• Maximum flexibility in ownership, profit splits, or bringing in entity/foreign members.
• Minimal corporate formalities and no mandatory owner payroll.
• Simpler compliance while you are finding product-market fit or have inconsistent profits.

Choose (or elect) an S corp if you want:

• Potential savings on self-employment (FICA) taxes once your profits can justify a formal payroll.
• A clean, traditional corporate structure with straightforward stock transferability.
• A governance model that investors and lenders often prefer for established operating companies.

Bottom Line​

Both LLCs and S corps protect your personal assets and allow business profits to pass through to the owners for tax purposes. The best fit depends entirely on your ownership structure, your expected profitability, and your appetite for formal governance and payroll.

Whichever you choose, disciplined bookkeeping matters far more than the entity's label. Keep your financial records precise, searchable, and reproducible with Beancount.io.

Build Tax-Ready, Investor-Ready Books with Beancount.io​

• Plain-text, version-controlled double-entry accounting.
• Clean charts of accounts designed for LLCs and S corps.
• Automated bank, credit card, and processor imports and reconciliations.
• Tax-ready exports and seamless accountant collaboration.
• A system that scales from a solo founder to a multi-entity enterprise.

Start a streamlined ledger for your entity today with Beancount.io.

This guide is for informational purposes and is not legal or tax advice. Consult your attorney or tax advisor for guidance specific to your situation.