Which is Better for You?
If you are starting your own company or looking to turn an existing sole proprietorship or general partnership to a business structure that offers personal asset protection, you’ve likely come across both corporations and limited liability companies (LLCs) as two excellent options.
The corporation is America’s oldest and most trusted business structure, and it’s a great fit for a wide variety of business types. The LLC is a more recent development on the American business landscape, but it’s become highly popular over the years because of its flexible format and user-friendly attributes.
It’s important to understand the specifics of each of these structures before determining which one is best for you particular business.
The corporation is a business structure that exists as a separate legal entity from its owners and shareholders. Because they are distinct entities from their ownership groups, corporations have their own set of rights. A corporation can buy, sell, own property, enter into contracts, and sue other persons and firms just like an individual.
Corporations also offer personal asset protection to their owners and shareholders. What this means is that if your business is sued, creditors cannot pursue your personal possessions and assets. Instead, they are limited only to the assets of the corporation itself, such as the contents of your business bank account.
An LLC is a private limited company that is specific to America. It combines the pass-through taxation structure of a sole proprietorship or partnership with the limited liability protection of a corporation.
Just like a corporation, an LLC’s personal asset protection stems from the fact that it exists as a separate entity from its owner or owners. Despite this distinction, an LLC offers a pass-through taxation structure by which business profits are only taxed as personal income, not as corporate earnings.
When it comes to taxation, there are actually three separate entities to discuss when comparing LLCs and corporations: The LLC, the C corporation, and the S corporation.
As mentioned above, LLCs enjoy a tax structure known as pass-through taxation, which means the profits of the company are “passed through” to the owners and solely taxed as personal income.
While LLCs are still subject to self-employment tax, the pass-through structure shields them from having to pay both corporate tax (currently 21%) and personal income tax on their business profits. Members and employees of LLCs are eligible to deduct the cost of health insurance and other benefits from their taxable income.
LLCs may also elect to be taxed like a C corporation. While not often the case, this structure may benefit some larger businesses.
A C corporation is the most common, and default, corporation type in America. C corps are subject to what is known as double taxation. When a C corp files taxes, its profits are first taxed at the current corporate tax rate of 21%.
Any business income paid out to the company’s ownership as dividends is then subject to personal income tax on their individual returns. Fringe benefits like health, disability, and life insurance are tax deductible as long as they are provided to 70% of employees.
For tax purposes, an S corp is very similar to an LLC. First, an S corp is not subject to double taxation, as it operates under a pass-through taxation structure. Also similar to an LLC, an S corp must pay self-employment taxes.
The biggest difference between the two structures is that an S corp does not enjoy tax deductible benefits. All shareholders who own at least 2% of an S corp must pay taxes on their health, disability, and other fringe benefits.
While S corps offer some benefits over C corps in terms of taxation, this structure is less common due to the strict requirements for qualification:
Longevity and Legal Precedent: Because the corporation as a business structure has been around for hundreds of years, the courts have ruled on just about every aspect of how they operate. Unlike the LLC, which is a newer business structure, the courts are extremely predictable in the way they’ll rule on issues related to corporations. This means that you can feel confident in the rights and protections afforded to you and your business under your corporation’s legal framework.
Attracting Capital: This is a major advantage for corporations in a few different ways. First, the ability to issue stock is a great incentive to potential investors, and gives owners a big leg up when it comes to raising capital for their businesses. LLCs are not able to offer this options when seeking investments.
Beyond outside investors, the ability to offer stock and/or stock options is also an attractive option for employees. It can give your company a competitive edge against other business structures when it comes to attracting and retaining the best talent. It also serves as an incentive for employees to do their best work, since they are vested in the company as stockholders.
No Self-Employment Tax: Unlike LLC owners, the owners of C corps are not subject to self-employment taxes. Self-employment tax is a 15.3% tax rate which covers both the employee and employer portions of Social Security and Medicare.
Simpler and Less Expensive Formation and Maintenance: Forming and maintaining an LLC requires little more than selecting a registered agent, filing Articles of Organization with your state of formation, and submitting annual reports.
Filing fees and annual fees vary considerably by state, but do not generally exceed a few hundred dollars. While the initial costs to form a corporation can be similar, both the tax liabilities and day-to-day operations can be far more burdensome than that of an LLC.
Flexible Structure and Management: Unlike a corporation that has a strict business structure that must conform with long-established rules and regulations, an LLC offers much more flexibility in how it is owned and operated.
An LLC may be owned by one person or by a group of people, and profits can be split in any way ownership sees fit — they do not have to be split evenly as with a corporation. Additionally, an LLC may be managed by its owner or owners, or by a designated manager selected from inside or outside the company.
Pass-Through Taxation: An LLCs pass-through tax structure can save business owners a considerable amount of money come tax time. While LLCs are still subject to self-employment tax, the pass-through structure shields them from having to pay both the corporate tax (currently 21%) and personal income tax on their business profits like most corporations.
Whether you’re forming an LLC or a corporation, you’ll have to decide whether you’d like to handle the formation yourself or hire a business services provider to do the leg work.
While forming a corporation can be more complicated than forming an LLC, having profession help can be invaluable when it comes to avoiding errors and saving time. There are several reputable companies that offer business formation services at a reasonable rate.
There are quite a few things to consider when you’re deciding whether to form an LLC or a corporation for your business.
You will need to consider the size, scope, and function of your business, and take into account your growth potential and how much flexibility you need or want in terms things like ownership, stock offerings, and taxation.
Each step of the decision making process should be taken with care and consideration of your specific circumstances, resources, and goals.