By Jade Yeban, J.D. | Legally reviewed by Aviana Cooper, Esq. | Last reviewed November 13, 2023
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When you're ready to turn your startup dream into a reality, choosing the right business entity is like picking the right foundation. Entrepreneurs face a big choice: forming a limited liability company (LLC) or a corporation. This decision affects everything from how you pay your income tax to how you protect your personal assets from business risks. LLCs and corporations offer different perks and have different rules.
This article is designed to help you figure out whether a corporation or an LLC for your business. Which one is going to be better for your business? Which one will be easier to create and maintain? Although this article cannot give you a firm answer one way or the other, it will attempt to show you the advantages and disadvantages of both corporations and LLCs.
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Many small businesses may find that the flexibility and simplicity of an LLC make it the better choice when it comes to forming a corporation versus an LLC. Like a sole proprietorship, LLCs offer liability protection, which means if your business stumbles financially your personal assets (like your house or car) aren't at risk. For a single-member LLC or small business owner, this is a major advantage.
If you plan on your business owning property, you will seriously want to consider forming your business as an LLC to avoid the problem of double taxes. This issue may crop up if the business is formed as a corporation. This double tax problem arises if the business owns property that appreciates in value and the business is formed as a corporation.
When this happens, both the corporation and the shareholders are taxed by the increase in property value when the property is sold or when the corporation is liquidated. Owners of an LLC, however, avoid this double taxation problem because the business' taxes are passed through to the owners of the LLC, meaning the LLC is not a tax entity in itself and does not pay taxes on its business income. LLCs are considered a pass-through entity, which means the Internal Revenue Service (IRS) doesn't require a separate corporation tax from you.
In an LLC, your operating agreement will be your blueprint. You don't need to host annual shareholder meetings or wrestle with too much record-keeping. An LLC can be easier to manage, more flexible, and often friendlier to your wallet when it comes to state fees.
If you're aiming to build a business empire, consider the corporation, or C corporation. This type of business is a legal entity that is separate from you, the owner, complete with the corporation's own legal rights. It's like creating another person who can own property, sue, or be sued. Corporations come with a formal management structure. This often includes a board of directors and corporate officers.
Corporations are often able to provide benefits to both employees and investors of the business. For example, if a person is both a shareholder of a business and is also employed as the business' chief financial officer, the corporation would be able to pay that person a salary and also provide benefits like health insurance.
Because of the setup of a corporation, the business will probably be able to deduct the costs of health insurance from its profits, and the benefit provided to the employee is not considered income. This is a great benefit of forming your business as a corporation. In contrast, an LLC can only deduct a portion of the cost of the health insurance premiums and other benefits paid for the employees.
Entrepreneurs looking for investment might prefer a corporation since you can issue various classes of stock to attract investors. Corporate income tax applies here, and you might face double taxation on the company profits and again once you receive your distributions. For the right type of business, with big plans and the need for a solid, traditional structure, this might be the way to go.
Finally, unlike an LLC, a corporation has a great incentive system built directly into the structure of the business that can help small businesses retain great employees. Corporations can offer their best employees stock options that, in addition to providing an incentive for employees to remain with a business, also provide an incentive for an employee to continue working diligently for the business.
Offering these stock options is an easier way to get employees a membership interest in the business, unlike LLCs, where it can often be difficult and complex to get employees into the membership circle.
An S corporation isn't a different entity type but a tax classification. You can elect this tax status with the IRS if you meet certain criteria, like being a U.S. citizen and having a certain type of business and number of shareholders. S corp status changes the tax file scene. Instead of facing corporate income tax, your company profits pass through to your personal tax returns, similar to an LLC.
There's a catch, as you and the other owners will have to pay Medicare and Social Security taxes on salaries. The S corporation is a hybrid, bringing together an LLC's tax benefits and a corporation's structure.
Under an S corp, you only pay self-employment taxes on the money you receive as compensation for your services, not on the profits that pass through the corporation to you. To make this clear, suppose you get $80,000 from your S corporation for the year, $60,000 of which was compensation for your services to the corporation. You will only pay taxes (15.3 percent) on the $60,000, not on the additional $20,000.
If your business is formed as an LLC, however, you may have to pay self-employment taxes on the entire amount of business profits that pass through to you automatically. Pass-through taxation is an important consideration when weighing LLC vs. S corp.
Picking the best entity for your business is important. Your choice should align with your business's mission and the level of personal liability you are comfortable with. If you want less complication with taxes and flexibility, an LLC could be your answer.If you're planning to scale up fast, invite lots of investors, and maybe go public one day, the corporation might be right for you. For those seeking a middle path, an S corp status might blend the best of both worlds.
In this quest to select the perfect business entity, don't do it alone. Enlist a legal guide who can help you navigate business law and choose the path that best suits your business venture and goals.
As you can see, corporations and LLCs each have their own advantages and disadvantages. Whether you're considering forming a corporation or an LLC, it's best to contact a business organization attorney if you have questions. Then, work with a lawyer or reputable business formation service to set up your business.
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