There are many good reasons, in making your choice of entity selection for a startup that desires to follow the traditional route of investment, hiring and growth to ultimate sale or IPO, to choose a C corporation rather than an S corporation or an LLC.
My top reasons for choosing a C corporation
- It is easier to form a C corporation than an S corporation or an LLC. (Simpler is not always but frequently better.) (For an example of what can go wrong with an S corporation election, see Rev. Proc. 2004-35.)
- You can issue qualified small business stock (“QSBS”) under Section 1202 of the Internal Revenue Code and potentially qualify for the exclusion from tax for QSBS and the rollover benefit under Section 1045 of the Internal Revenue Code. [For qualified small business stock acquired between the dates of September 27, 2010 and December 31, 2013, the tax rate after holding the stock for 5 years is ZERO--including a complete AMT exemption (subject to a cap (but a substantial one)).]
- You avoid having to issue your owners Forms K-1, subjecting them to federal income tax on the entity’s income (regardless of whether that income is distributed to them), and potentially subjecting them to state income taxes in the various states in which the entity has income tax nexus.
- You avoid having to agree to a cash distribution scheme to cover the taxes of the owners on the entity’s income taxed to them. This may make it easier to reinvest capital to grow the business.
- It is easier for a C corporation to engage in an equity or debt financing.
- Venture capitalists typically won’t invest in LLCs and can’t invest in S corporations.
- Only C corporations can go public (generally).
- Equity compensation in a C corporation is easier.
- C corporations can participate in tax-free reorganizations under the Internal Revenue Code. LLCs taxed as partnerships cannot. What this means is this–if you are operating as an LLC and are offered to be bought out by another company for stock, your receipt of that stock will be taxable to you–even if the stock is not salable and can’t be sold to generate cash to pay the tax. With corporations, it is possible to be bought out for stock on a tax-deferred basis, and not pay tax on the stock received until you sell it. This is an important exit strategy consideration.
- There are potential self employment tax savings over what would be possible with an LLC.
- There is no limit on the type or number of shareholders that you can have.
- The dreaded “double tax” that everyone is afraid of with C corporations rarely ever occurs (there are, of course, exceptions–the cash cow business being one). Most positive exits are 1 layer of tax events–either stock sales or mergers structured so that there is only 1 layer of tax–at the shareholder level.
- Although losses cannot be deducted by the shareholders of a C corporation, losses frequently cannot be deducted by non-active members of the company in any event–so the loss pass through benefit to passive investors is frequently in fact not very helpful.
- The actual tax benefit of the pass through of any losses may turn out to be substantially less than expected.
- The tax accounting complexities associated with maintaining capital accounts in accordance with the Treasury Regulations make LLCs expensive for companies that desire to raise multiple rounds of financing.
- LLCs may have to remit tax payments to the IRS on allocations to foreign owners. See IRC Code Section 1446.