When setting up a business in the U.S., one of the most important decisions is choosing between forming an LLC (Limited Liability Company) or a C-Corporation (C-Corp). Each structure has distinct tax implications, especially for foreign founders, small business owners, and startups. In this article, we'll break down the tax differences in plain language so you can make the right choice for your situation.
1. Pass-Through vs. Double Taxation
This is one of the biggest tax differences between an LLC and a C-Corp:
- LLC: An LLC is typically a pass-through entity. That means the business itself doesn't pay income tax to the IRS. Instead, the profits are passed directly to the owner(s), who report the income on their personal tax returns. The IRS treats it as if the business and the owner are the same for tax purposes. For example, if you're the sole owner, you’ll include the profits on your Form 1040 using Schedule C. If there are multiple owners, the LLC files Form 1065, and each owner gets a Schedule K-1 showing their share of the income.
- C-Corp: A C-Corporation is treated as a completely separate entity for tax purposes. It must file its own tax return (Form 1120) and pay corporate income tax on its profits. If the C-Corp distributes those profits to shareholders as dividends, the individual shareholders must also pay tax on that income on their personal tax returns. This is known as double taxation—first at the corporate level, and again at the personal level.
2. Business Expenses and Write-Offs
Both LLCs and C-Corps can deduct ordinary and necessary business expenses. These are often called “write-offs.” In simple terms, a write-off is any cost directly related to running your business that helps reduce your taxable income.
- Common deductible expenses for both structures include:
- Office rent
- Software subscriptions
- Professional services (accountants, lawyers)
- Advertising and marketing
- Business travel and meals
- Equipment and supplies
- Contractor payments
- C-Corp advantage: C-Corps can also deduct the cost of certain employee benefits—like health insurance and retirement plans—as business expenses. These are typically not considered income to the employee, making them a tax-friendly perk.
- LLC note: LLCs can also deduct many of the same expenses, but if benefits like health insurance are paid to members, those benefits may count as personal income. This can reduce the overall tax benefit.
- Important: Not all expenses are fully deductible. For example, only 50% of most business meals are deductible, and entertainment costs are generally not deductible at all. Keep good records and work with a tax professional to make sure your deductions are done right.
3. Foreign Ownership Considerations
- LLC: U.S. LLCs with foreign owners face complex filing requirements, including Forms 5472 and 1120 (pro forma). Foreign owners are also subject to U.S. tax on effectively connected income (ECI) and may have to file Form 1040-NR. However, if a foreign person does not have ECI, they generally do not owe U.S. income tax on the LLC's income. The income still passes through to the foreign owner's personal tax return in their home country, subject to that country’s tax laws. That said, proper documentation and analysis are critical to ensure that no U.S. tax liability arises inadvertently.
- C-Corp: Often easier for foreign founders, as the C-Corp pays U.S. tax, and dividends to foreign shareholders are generally subject to a flat 30% withholding tax (unless reduced by a tax treaty).
4. Getting Money Out of the Business
- LLC: Since an LLC is a pass-through entity, owners can generally withdraw money from the business bank account at any time. These distributions are not considered a salary or wage—they’re simply a draw of the owner’s share of profits. There’s no requirement to run payroll for the owner unless they have elected to be taxed as an S-Corp.
- C-Corp: With a C-Corp, the money belongs to the corporation—not the owners. To legally take money out, shareholders must be on payroll and receive wages (subject to payroll taxes), or receive dividends (subject to double taxation). You cannot simply transfer funds from the business account to your personal account without following these formalities, which adds complexity and compliance requirements.
5. Self-Employment Taxes (for U.S. Persons)
This primarily applies to U.S. citizens and residents who are subject to U.S. self-employment tax rules:
- LLC: If you're a U.S. person and an active member of an LLC, you're generally considered self-employed. This means you'll pay self-employment taxes (currently around 15.3%) on your share of the business income. These taxes cover Social Security and Medicare. You pay these in addition to your regular income tax.
- C-Corp: If you're working in your C-Corp, you’re treated as an employee. The corporation pays you a salary and withholds payroll taxes from your paycheck. You receive a W-2 at the end of the year. Dividends paid to shareholders are not subject to self-employment taxes but are still subject to income tax.
Which Should You Choose?
- Choose an LLC if you want pass-through taxation, more flexible profit sharing, and simpler operations (especially if you’re a U.S. person).
- Choose a C-Corp if you plan to raise venture capital, need to reinvest profits, or want to offer employee benefits. It's often the preferred structure for startups and foreign founders.
Need Help Deciding?
Tax implications can be complex and vary based on your unique situation. Book a free consultation with Bookmate to discuss the best structure for your business.
You can also learn more about forming your U.S. company the right way at trybookmate.co.
Remember: Every tax situation is unique. This article is for informational purposes only and does not constitute legal or tax advice. Speak to a qualified professional to make the right decision for your business.
