What is the difference between a C corporation and an S corporation?

Both S and C corporations are formed the same way - by the filing of Articles of Incorporation with the Secretary of State's office. As a legal matter, the S corporation is identical in many ways to the C corporation because both limit the shareholders' personal liability. But as a tax matter, the S corporation offers the advantage of avoiding taxation at the corporate level. In order to obtain S status, a company files Form 2553 to "elect" to be treated as an S corporation. If accepted by the IRS, the company is then taxed like a partnership. The corporation is not taxed, but the income flows through to shareholders who report the income on their individual returns.

Note that the 2553 is a tax election only; and enables the shareholder to treat the earnings and profits as distributions, and have then pass thru directly to their personal tax return. The catch here is that the shareholder, if working for the company, and if their is a profit, must pay herself wages, and it must meet standards of "reasonable compensation." This can vary by geographical region as well as occupation, but the basic rule is to pay yourself what you would have to pay someone to do your job, as long as there is enough profit. If you do not do this, the IRS can reclassify all of the earnings and profits as wages, and you will liable for all of the payroll taxes on the total amount.

Answer provided by Chuck Roach - Roach Law Office

How is the LLC treated for tax purposes?

The LLC enjoys the same "flow-through" tax treatment that partnerships and S-Corporations do. The rules concerning capital accounts, contributions and other basic partnership taxation principles apply to LLCs as well. In short, this means that although the LLC must file a tax return, the LLC owners report income and pay the taxes owed on such income using their personal returns.

The LLC itself does not pay taxes on its income. (Currently, the IRS has not developed a separate tax return form for LLC, so the same form used for partnerships is used, Form 1065). The owners will each file a Schedule K-1 with their personal income tax return, which will show their "share" of the LLC income. While this structure avoids the double taxation dilemma of the C-corporation, an LLC (like the partnerships and an S-corporation) cannot retain earnings without the owners of the business having to pay income taxes on those earnings anyway.

One of the very best features of the LLC is the fact that the owners can divide up the ownership interests differently from the rights to distribution of profits (and losses). For example, an individual goes into business with another person, and both wish to own 50% of the business. However, one individual is going to work for the LLC full-time while the other wishes to keep another full-time job and work for the business part-time. Each may still own 50%of the ownership while dividing the profits interests into a 75%-25% split or some other ratio, to reflect the different levels of effort.

Answer provided by Chuck Roach - Roach Law Office