C-Corporation

Advantages

• Limited liability of shareholders. The C corporation is a separate legal entity, and if it is adequately capitalized and proper corporate formalities are followed, the shareholders should generally have liability protection from the debts and obligations of the entity.
• Easier to raise capital through public offering of stock.
• Shareholders of publicly traded corporations can come and go with ease.
• No shareholder-level tax on undistributed income.
• Given the duration that the C corporation entity form has been in existence, a well-established body of law is available with respect to both the tax and non-tax legal treatment of C corporations.
• No ownership restrictions apply (in contrast with the ones to which the S corporation is subject).
• Multiple classes of stock permitted (unlike for S corporation).
• Code Sec. 1202 reduced rate of capital gains taxation on the sale of qualified small business stock.
• Code Sec. 1244 ordinary loss deduction for a failed small business corporation.
• The ability to file consolidated returns with controlled subsidiaries.

Disadvantages

• Double taxation. Income is taxed twice, first at the corporate level and second when earnings are distributed to shareholders in the form of dividends.
• No capital gains rate differential; all income is taxed on the same rate schedule.
• Distributions of appreciated property usually triggers gain at the corporate level.
• Formalities and regulations must be followed very closely in conjunction with the laws regarding incorporating in a specific state; failure to do so can create a situation where shareholders may be held liable.
• Costlier to start than other business entities.
• More time and effort to maintain.
• Potential tax traps, such as the accumulated earnings tax (Code Sec. 531) and personal holding company tax (Code Sec. 541).
• Shareholders do not benefit from corporate losses.
• C corporations generally are required to use the accrual method of accounting, which can result in owing taxes on income that has not yet been received.

S-Corporation

Advantages

• Shareholder limited liability. The S corporation is a separate legal entity, and if it is adequately capitalized and proper corporate formalities are followed, the shareholders should generally have liability protection from the debts and obligations of the entity.
• An S corporation can easily convert to a C corporation if a public stock offering becomes desirable.
• Corporate losses flow through, which shareholders may be able to use to offset other income.
• An S corporation usually has the option of using the cash or accrual method of accounting.
• S corporation earnings are not subject to self-employment taxes; however, IRS established precedence with Revenue Ruling 74-44 that requires S corporations to pay reasonable salaries to shareholder-employees, or risk having the distribution to a shareholder be reclassified as taxable salaries.

Disadvantages

• Cannot have more than 100 shareholders.
• Cannot have as a shareholder a person who is not an individual other than an estate, trust, or certain tax-exempt organizations.
• Cannot have a nonresident alien as a shareholder.
• Cannot have more than one class of stock.
• Code Sec. 1374 built-in-gains tax on sale of assets within ten years after conversion from C-Corporation to S-Corporation.

Multi-Member LLC, taxed as a Partnership

Advantages

• Provides limited liability for its members.
• No limitations on the number of members, as is the case for the S corporation.
• Allows for varying classes of membership.
• An LLC is permitted to specially allocate income and losses among its members.
• Losses of an LLC flow through to the members; however, the members can use the losses only to the extent of their tax basis in the LLC.
• Members, subject to certain exceptions, are allowed tax basis for the LLC's debt, which enhances the ability to use losses that flow through.
• Tax-free distributions of appreciated property to the extent of basis.
• Ability to elect step up members' interests in the LLC.

Disadvantages

• Given the relatively young age of the LLC as an entity form, the body of law is less established, and therefore, less certain.  Although, the State of Delaware has well established case law regarding LLCs.
• Losses on Small Business Stock. {Code Sec. 1244}  does not apply to LLCs.
• Limitations imposed on contributions and distributions pursuant to Code Sec. 704(c).
• Transfer of 50% or more of the membership interests terminates the LLC.
• Disposition of an LLC interest can result in taxation at ordinary income rates under certain circumstances.