One of the very first steps in starting a business is to form a business entity. But with more than one option of business entities to choose from, this is sometimes one of the most difficult steps. Should you choose a LLC or a corporation? Which one is better suited for you and your associates, if you have any. Or maybe it is another business entity, entirely different that is better for your plans.
Difference between LLC and Corporation
To start with, both LLCs and corporations are business entities that can be formed by following a similar procedure including filing a list of documents with the state. Choosing either LLC or corporation as a business entity you benefit as owner by the same type of liability protection – you are not generally personal responsible for business obligations.
LLCs or Limited Liability Companies are business entities similar to corporations. The differences include more flexibility in management and taxation and less requirements regarding recordkeeping.
Corporations are a better option if you are planning to seek outside investors because the shares are easier to transfer. This form of business entity offers perpetual life and a predictable structure.
Corporation vs. LLC Ownership
As an owner of a corporation you will be considered a shareholder and you will own a number of share issued by the corporation according to the percentage of your ownership in the corporation. If you are a shareholder in a corporation that has issued 15,000 shares and you own one third of the corporation, this means you will own 5,000 shares. A much appreciated advantage of the corporation as a business entity is that shares are relatively easy to transfer. Additionally, corporations have perpetual life, so if another shareholder choses to leave, sell his or her shares or dies, the corporation’s existence is not threatened.
As a LLC owner you will be called a member and you will own a percentage of the business, sometimes named “membership interest.” The difference between corporations and LLCs regarding ownership is that in this case you will generally meet restrictions if you want to transfer LLC membership interests such as the necessity of requiring the other members’ approval. Depending on the state you are in, your LLC might need to be dissolved if a member decides to leave, dies or files bankruptcy.
For a small business with carefully chosen business partners, an LLC can be the right business entity to go with. If your business plans include seeking outside investors or providing shares to your employees, than the advantages of a corporation are more suited to your needs.
LLC vs. Inc. Management and Recordkeeping
The management structure of a corporation must include a board of directors with the role of overseeing the “big picture” issues. It also needs to include officers with the responsibility of running the day-to-day affairs of the company. A corporation management includes a series of requirements such as annual reports that need to be made and annual shareholder meetings that need to be held.
The management of a LLC is generally simpler than that of a corporation, most of such business entities being managed by their members or a designated group of managers and functioning like a traditional business membership. Formal business titles are not very important in a LLC, there is a minimal recordkeeping requirement and there are a few states where LLCs don’t even have to make annual reports. If there are members that own a part of the LLC, but don’t have an interest in being actively involved in the business activity, they can choose to have the LLC manager-managed.
The choice between LLC and corporation can be made by thinking about who will be a part of the business entity and what plans you have for financing. If you are a group of owners actively participant in the business, an LLC might be better for you. If you plan to attract financial investors and expect to have many owners, a corporation is the most appropriate form to choose.
S Corp. vs. LLC: Taxes for LLCs and Corporations
If you choose a corporation as the form for your business, you will be taxed as either a C corporation or an S corporation. Unlike corporations which have their own tax classification, LLCs offer you the flexibility to choose how you want to pay your taxes: as a sole proprietorship, as a partnership, an S corporation or a C corporation.
- As a C corporation you will pay corporate income tax on the profits obtained by your business. As a shareholder you will also pay personal income taxes on the profits you receive as dividends from your corporation, a system frequently criticized as being a “double taxation.”
- You can avoid double taxation if you choose an S corporation. In this case, profits obtained by the corporation pass through to the shareholders and shareholders pay the taxes on the profits along with their other personal tax returns. In order to benefit from this form of taxation there must be maximum 100 shareholders (which cannot be corporations, partnerships or non-resident aliens). There also must be only one class of stock. If your corporation or LLC doesn’t meet these criteria, it can be taxed either as a C corporation (if it is a corporation) or a sole proprietorship or partnership (if it is a LLC).
- If you choose to pay your taxes as a sole proprietorship or partnership, you need to know that this form of business reports income on their owners’ personal tax returns. An option that can work very well for a small business with small profits. However, it can be disadvantageous if you start making a lot of money, since as a sole proprietor or partner you are considered self-employed and you will be expected to pay Social Security taxes up to the maximum and Medicare taxes on all the profits obtained.
While taxation might not be the deciding factor for you and your partners when choosing the right business entity to create, it is important to have all your information before beginning a business, including how your business will be taxed.
While both LLCs and corporations offer the advantage of limited personal liability, LLCs are frequently favored by the small, owner-managed business looking for a less formal structure. On the other hand, for owners looking to attract outside investment, the more formal structure of a corporation might be the ideal solution.