Which Is Better for You: LLC or Corporation?
When you are in the beginning stages of your business, one of the biggest decisions that you have to make is the type of business structure you should form. There are many options available, but for many new business owners the decision comes down to an LLC or a corporation. There are many benefits to both as well as some disadvantages. Whichever you choose for your business, you cannot go wrong. You should make an educated decision prior to forming your business structure. Use this guide to get started.
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What Is an LLC?
LLC stands for Limited Liability Company. Out of all the business structures, it tends to be the least complex, which is why it is a very popular option for business owners. Even if you already have a business in another structure, you may find it easy to convert to an LLC to enjoy some of the benefits. An LLC combines some of the taxation benefits of a partnership or a sole proprietorship with a corporation's limited liability.
What Is a Corporation?
A corporation is different from an LLC in many ways. What makes it different from many other business structures is that it is an independent legal entity. This is, however, one of the ways that it is similar to an LLC. By choosing this type of structure, you also get to separate the business from yourself in terms of liability and protecting yourself from the corporation's debt. However, it also allows the business to enter into contracts, pay taxes, and even incur debts separate from you as the owner. Another big component of a corporation is that the business will not dissolve if the owner changes to another owner or if the owner dies.
What Are Some Advantages of Both?
As with any business entity, there are benefits that can be enjoyed. Knowing what you can gain from the specific types of entities can help you make the right decision.
The structure of an LLC is flexible because owners can override lax laws by building their own set of rules into the operating agreement of the company. In addition to this benefit, there are other advantages such as limited liability and legal protection for personal assets. The following points outline some of the advantages of choosing an LLC:
- There is increased legal protection for owners due to limited liability – This means that your business debts and obligations cannot be linked to your personal assets. If you file for bankruptcy for your business, your personal assets cannot be used to pay those business debts. However, during the course of business, if an owner acts illegally, irresponsibly, or unethically, the law trumps this and they cannot be protected by their LLC.
- Owners are not required to be U.S. citizens or permanent residents – With no residency requirement, individuals who do not fall within these classifications still have the option of forming a business within the United States. Individuals without residency will find that there are some tax options they cannot use as a result.
- An LLC makes it easier to add investors without changing the structure – The business will look more favorable to any potential partners, lenders, suppliers, and other individuals you may want to do business with to grow your company. This allows you to easily grow the business in ways you see fit.
- An LLC allows for pass-through taxation – When you have an LLC, you are not required to file a corporate tax return every year as long as there is no election to file as a corporation. Instead, owners should report their share of profit and loss in terms of the business on their individual tax returns and file Form 1065. This allows you to avoid double taxation which can often happen to business owners of other business structures because they pay taxes for the business as well as on their personal profit or pay. This is because an LLC is not a separate taxable entity.
In addition to the limited liability aspect of a corporation, there are many other benefits you can enjoy when you choose a corporation as your business structure. The following points outline some of the benefits of choosing a corporation:
- Using it to create more capital – With a corporation, you can sell shares of the company as stocks as a way to increase more capital for the business. This is a good way to increase money to grow the business. You can choose to do this privately or publicly and it is a very common choice to grow capital.
- Protecting your personal assets – Your company will only be liable for the assets of the business, so your personal finances are never in play. If you do ever run into financial issues within your corporation, your personal assets will not be used to pay for those debts.
- Taking advantage of some corporation tax benefits – There are some tax benefits only available for corporations that can be used to benefit the business.
- The corporation can live on and on – This is known as perpetual life. No matter what happens to the owners of the business, the corporation can go on as long as there is a new owner in place. That means it can be sold and still remain active.
- The management can run independently from the owners – For some corporations, you may have a lot of different investors who do not have a majority interest. If no one owns the majority of the company, then the management team of the corporation can run the business how they see fit without consulting the owners. If you are the owner of the company, this is a drawback because you will not have much say, if any at all, on how the business operates, but it can also be viewed as an advantage for many business owners. The only way to change this is by keeping a majority share, or 51 percent, of the company in your possession.
- You can take taxes as an S corp – This can be a huge advantage because it will save you money in the long run. When you take taxes as an S corp, the corporation is not subject to federal income taxes. Shareholders are instead taxed on their allocated share of the income and they do not have to pay self-employment tax. Companies will use Form 1120S for the annual tax return.
What Are Some Disadvantages of Both?
Just like there are advantages you can enjoy, there are also some disadvantages to consider. Having the full picture of what to expect can help you better prepare for the possibilities that await.
Before you choose an LLC, you need to know what kind of disadvantages you may face as well. Just like with any structure, there are benefits and drawbacks to consider. These are some of the main disadvantages of an LLC:
- You will be limited in terms of growth – If you choose to structure your business as an LLC, you will not be able to issue shares of stock to attract investors and increase your investment potential. Instead, you will have to look for other ways to increase your capital. While there are other ways to increase capital, issuing shares of stocks is a very popular option that can take businesses to the next level. If this is something you had planned on doing in the future, then an LLC may not be the right option for you.
- LLCs may be treated differently in some states – Currently, there is not uniformity when it comes to LLCs. Because of that, there are different sets of laws in all states. While some may be similar, there are other states where there are differences. If a goal is to grow your business into other states, you would have to re-register in each state. Because the laws are not always the same, this may mean restructuring the entity. If you are looking to create a business that you can grow and open in different markets in a variety of states, this will only complicate things for you. It may become more uniform in the future, but it is not something you should count on when you are choosing a business structure, especially since it is not something that is guaranteed.
- Your earnings can be subject to self-employment tax – Since you will not be filing a corporate tax return—one of the advantages of an LLC—you will be subject to other forms of taxation. This disadvantage can cost you more than you planned on and it is best to weigh your options and your tax requirements to determine if foregoing the corporate tax return is still cheaper than self-employment taxes. You should reach out to an accountant to help you determine which of these is more beneficial to you in the long run.
- You can be taxed for your appreciated assets – If you convert an existing business to an LLC, there are different taxations that can be used against you that will end up costing you more money in the long run. One of these is the tax recognition on appreciated assets. If you gain appreciated property as a result of the conversion or bring appreciated property into your business, then you may have to pay taxes on these at the end of the year that you have not yet considered. It is common to gain tax benefits from appreciated assets, but in this case, you will have to pay taxes on the full value at the time of conversion or purchase, resulting in taxes on the appreciation.
While there are definitely some advantages to choosing a corporation business structure, there are also some drawbacks. These are some of the main disadvantages:
- You are subject to double taxation – It depends on the type of corporation that you choose, but some require that the business pay taxes on the income. After that, any shareholders or owners will have to also pay taxes on their dividends, which results in taxes being taken out twice for the same money. Keep in mind that with smart planning, this can be minimized.
- You may have excessive tax filing requirements and paperwork – This results in other taxes that will need to be paid. Not only is this more money that has to be paid out, but it can also lead to a lot of excess paperwork for you.
- There are extensive filing and record-keeping requirements – This is one of the biggest considerations when it comes to choosing a corporation as a business entity because it is something that is regulated by law. The IRS sets how documents will need to be kept and filing that needs to be done on a periodic basis. This can be very time consuming for a business. Some of the documents and records that need to be maintained include tax returns and supporting documents, employee tax records, human resource files, and more.
Choosing between the Two
As you can see, there are benefits and drawbacks to structuring your business as an LLC and a corporation. This is a big decision for your business and one that you should not take lightly. If you are still not sure which way you should go with your business structure, you may want to start by laying out your short- and long-term goals. Once you know what you want the future to look like for your business, you can weigh the advantages and disadvantages of each to determine what works best for your business.
Your Plans and Goals
Every business is unique, so you should make sure you are taking into account your unique plans and goals. Just because one may work for another business does not necessarily mean it will work for yours.
Now that you know the details of both LLCs and corporations, you are better equipped to make a smart business decision and set yourself up for success for many years to come. Knowing where to begin is half the battle, and this guide can serve as a good starting point for your business. For more information on what you need to do to start your business, take a look at the legal documents you may need during formation.