The following chart lists some principal considerations in selecting the form of business entity and applies them to the C corporation, S corporation and limited liability company (“LLC”) entity forms.
The considerations are listed in no particular order, in part because their importance will vary with each business formation depending on the nature of the business, sources of financing and the plan for providing financial returns to the owners (e.g., distributions of operating income, a public offering or a sale of the business). Other factors that are not listed will also influence choice of entity. In addition, the “yes or no” format oversimplifies the applicability of certain attributes. Note that the chart assumes the LLC entity form is classified as a partnership for income tax purposes.
Learn more about each entity in our accompanying articles:
|C Corporation||S Corporation||Limited Liability Company|
|Tax Free In Kind Distributions||No||No||Yes|
|Qualified Small Business Stock Exclusion for Gains||Yes||No||No|
|Limitations on Eligibility||No||Yes||No|
|Limitations on Capital Structure||No||Yes||No|
|Unrelated Business Taxable Income for Tax Exempt Investors||No||Yes||Yes|
|Ability to Take Public||Yes||Yes(A)||No(C)|
|Flexible Charter Documents||No||No||Yes|
|Ability to Change Structure Without Tax||No||No||Yes|
|Availability of Tax-Free Corporate Acquisition Provisions||Yes||Yes||No|
|Favorable Employee Incentives (including incentive stock options)||Yes||Yes/No(B)||Yes/No(D)|
|Basis Step-up from Undistributed Earnings and in Taxable
(A)If S corporation eligibility requirements are met, it is simple to incorporate and make the S election. However, S corporations must follow very strict requirements to avoid automatic reversion to C corporation status. Attention to preserving S corporation status can complicate ongoing operations and/or future exits.
(B)Although LLC/tax partnership equity does not itself qualify as QSBS, LLCs typically can convert to C corporation form on a tax-free basis, with the successor C corporation’s stock qualifying as QSBS if all eligibility requirements are met at that time.
(C)S Corporation would automatically convert to a C Corporation upon a public offering because of the number of shareholders.
(D)Although the public markets are generally not available for partnership offerings, a partnership or LLC can be incorporated without tax and then taken public, or it may go public indirectly through more complicated entity structuring, which may be advantageous in certain circumstances.
(E)Although S corporations cannot convert to LLC/tax partnership form on a tax-free basis, they can become C corporations without tax simply by revoking their S election or violating the S corporation eligibility rules (e.g., issuing preferred stock).
(F)While LLCs cannot take advantage of the reorganization provisions of the income tax law for tax-free treatment of acquisitions (since those are limited to corporations), they may sometimes be able to be acquired on a tax-free basis and may generally acquire business entities on a tax-free basis.
(G)Although an S Corporation can issue incentive stock options (“ISOs”), the inability to have two classes of stock limits favorable pricing of the common stock offered to employees.
(H)Although partnership and LLC interests can be provided to employees, they are poorly understood by most employees and so typically are appropriate for and limited to a small number of the most sophisticated executives. ISOs are not available.
A video on this topic is available on Cooley’s Taxplaining page.
Last reviewed: October 25, 2022