LLC or Corporation - Which Should I Select for My Business?
Everyone loves to give advice to new business owners. One common piece of advice goes like this: "Don't form an LLC. Form a corporation." Or, "Corporations are too complex. Just form an LLC." Confused? Let's sort out the differences between an LLC and a corporation so you can decide which business type is best for your business.
LLC or Corporation - What's the Difference?
Business organizations (not including sole proprietors) must register as a specific business type with the state in which they do business. All states recognize businesses formed as corporations, limited liability companies (LLCs) or partnerships, or variations of these forms.
This article gives you some information on differences and similarities between LLC and corporation business forms, the two most popular business types.
Why Is an LLC NOT a Corporation?
There's no such thing as a "limited liability corporation." An LLC is a limited liability company. It's not a corporation, and you don't incorporate a business as an LLC. Both register with a state, but an LLC doesn't "incorporate."
How are Corporations and Limited Liability Companies Alike?
Liability for Corporations and LLCs
Both corporations and LLCs limit the liability of the owners/shareholders from the debts of the business and against lawsuits against the business. Both business types must work to keep their operations separate from the activity of the owners to maintain their liability protection.
First Difference - How the Business is Formed
Forming an LLC. An LLC is formed by one or more business people, as owners. The owners, called "members," file Articles of Organization to form the business. Then they agree on an Operating Agreement to use in managing the day-to-day activities and decide on each member's percentage share of ownership.
Forming a Corporation. A corporation is formed (incorporated) by filing corporate organization documents in the state where the corporation is located. The corporation also creates a Board of Directors to oversee the corporate business and the board agrees on bylaws, operating documents. The corporation may be a stock corporation, with shares of stock and stockholders, the real owners of the business.
Second Difference - Business Ownership
The main difference between LLC's and corporations is the ownership of the business. You might say that a corporation is owned by individuals who purchase shares, while the LLC is owned by individuals.
LLC owners have an equity interest in the assets of the business because they have made a contribution to join the business, shown in the business balance sheet as owners equity, while corporate owners are shareholders or stockholders who have shares of stock
Third Difference - Profits and Losses
The profits and losses of an LLC and a corporation are handled differently. LLC profits and losses are passed through to individual owners, while corporate profits and losses are held by the corporation.
LLCs as Pass-through Businesses. Pass-through businesses are those in which the profits and losses of the business pass through to the owners or shareholders. In other words, the business income is considered as the owner's or shareholder's income, and the owner/shareholder pays the tax on his or her personal tax return. Limited liability companies, like partnerships and sole proprietorships, are pass-through entities.
Corporations as Separate Business Entities. Corporations are separate businesses entities. The profits and losses of the corporation are held by the corporation and are not passed through to the owners directly. Yes, some earnings of the corporation may be paid to the owners in dividends, but this isn't direct. Some earnings may be kept by the corporation.
Fourth Difference - Taxes for Corporations and LLCs
Corporations and LLCs are different in how they are taxed. Because corporations are separate entities, they are taxed at the corporate rate, while LLCs are taxed based on the total Adjusted Gross Income of the owners. Here is an example:
A corporation has a profit of $350,000 for the year. That profit is taxed at the corporate tax rate (21 percent, beginning in 2018).
An LLC has the same amount of profit of $350,000. Its two Members each have a 50 percent share in the LLC, so each one is taxed on $175,000 of income on his or her personal tax return. The income from the LLC is included in the owner's personal tax return on Form 1040 on line 12 and is considered along with other income for that person or couple for that year.
Self-employment Taxes and FICA Taxes. LLC owners also must pay self-employment taxes (Social Security and Medicare) on their share of the LLC's profit each year. Corporate shareholders aren't self-employed so they don't have to pay this tax. Corporate owners who work as employees have FICA tax (Social Security/Medicare) taken from their paychecks.
Corporate and LLC Owners and Taxes
The tax consequences to LLC and corporate owners are different. Owners of a corporation are not paid, but they receive dividends; they are taxed on their dividend income. Owners of an LLC are taxed like partners in a partnership; that is, they receive a distributive share of the profits each year and pay taxes on that share on their personal tax returns (that pass-through concept discussed above).
Owners of an LLC also pay self-employment tax on their income from the business, while corporate owners who work in the business are considered employees and pay tax on their employment income, along with FICA taxes (Social Security and Medicare).
How you are paid - and taxed - as an owner of an LLC or a corporation could be a major factor in determining which form of business you choose.
A Special Tax Case - The Single-member LLC
A Third Possibility - An LLC Taxed as a Corporation
Just to muddy the waters, you might want to consider forming an LLC and then electing to have the LLC taxed as a corporation or S corporation. While this is more complicated, it combines the simplicity of the LLC with the tax benefits of a corporation.
Who Can Help Me Make This Decision?
Still confused about whether to start an LLC or a corporation? It's a complex decision and one you shouldn't make quickly. As noted above, the tax consequences can be a deciding factor. and every business situation is unique. Before you make a decision, talk to two people:
1. An attorney who has experience with both LLC's and corporations. A good attorney will consider LLC's in addition to traditional corporations.
2. A CPA who understands the tax differences between LLC's and corporations.
This article about 7 questions to ask before deciding on a business type might also be helpful.
For more information, check out this complete outline to my Guide to Business Types