As an entrepreneur, you might stand at a crossroads where you’d have to choose between an LLC and a Corporation.
Now, LLCs are great options for entrepreneurs who’re just starting out. But why choose an LLC over a Corporation?
To understand that, it’s important to figure out what both these business structures are all about and how they’re different from each other.
Based on their pros and cons, we’ll also figure out why you should choose an LLC over a Corporation, especially if you’re just starting out. You can find a lot of useful information about LLCs and Corporations on llcguys.com, but now lets focus on this article.
So, let’s dive right in.
Table of Contents
What is an LLC?
An LLC or Limited Liability Company is a business entity that’s become extremely popular among small and medium-sized businesses.
It’s a legal entity, just like a Corporation, and provides liability protection to its owners, who are called members.
What makes it even better is the fact that it can have multiple owners and the income of the business passes to their personal income as well.
What is a Corporation?
A corporation is a legal business entity that works extremely well for large businesses and offers a predictable structure and easy share creation and distribution, among other things.
Like LLCs, Corporations provide liability protection to its owners, who are typically called shareholders. This means that they’re not personally responsible for the obligations of the business entity.
Additionally, Corporations have a perpetual life. This means that they can possibly go on forever even if the leadership changes.
There are two types of Corporations, let’s take a look at them.
C-Corporations are the default Corporations under the IRS rules. They’re considered separate taxable entities and you’re subjected to double taxation when you run your business using this business structure.
Also, you can have unlimited shareholders in C-Corporations and there’s no restriction on the ownership.
S-Corporations help you avoid double taxation. However, there’s a cap on the number of shareholders (100) these entities can have. Also, there may be certain restrictions when it comes to transferring of shares between various shareholders.
Ownership Structure: LLC vs. Corporation
Corporations and LLCs can both have multiple owners. However, there lies a difference between the two.
Every shareholder in a Corporation owns shares equivalent to their stake in the business. These shares are easily transferable too and essentially this is what enables the perpetuity of the Corporation.
On the other hand, in an LLC, the members each own a percentage of the business. However, there are almost always some restrictions when it comes to transferring this ownership between the members.
As a result, the LLC may have to be dissolved in some cases if a member leaves, dies, or goes bankrupt.
However, these restrictions work well if you’ve got a small business.
Starting the Business: LLC vs. Corporation
The process of starting an LLC is easier than that of a Corporation. You have to file your Articles of Organization with the Secretary of State and draft an LLC Operating Agreement. Along with this, you’d also need to pay the state filing fees.
On the other hand, to start a Corporation, you have to first file your Articles of Incorporation. You’ll also have to draft your Corporate Bylaws, and issue and record shares.
Irrespective of which business structure you choose, you can take help from a company like GovDocFiling to make it easier. They can file all the documents and even expedite the process for you.
Managing the Business: LLC vs. Corporation
One of the major reasons why you should choose an LLC over a Corporation is the ease of managing the business.
Corporations have a rigid management structure. You must have a board of directors and officers who oversee the operations of the business.
Additionally, you’re required to conduct annual general meetings and create reports about the same.
LLCs don’t have such hard requirements. You don’t even need formal business titles for each member. Additionally, you can choose to have a few managers who manage the entire business. Some states don’t require you to create annual reports too.
All of these advantages make LLCs a very attractive option for SME business owners.
Taxation: LLC vs. Corporation
Taxation is one of the biggest moot points when it comes to choosing an LLC over a Corporation.
The best part about an LLC is that the profit or loss of the business passes through to the members.
This means that you’re saved from double taxation. However, you would be required to pay a self-employment tax in this case.
If you wish to avoid this tax, you would have to get the LLC taxed as an S-Corporation. These S-Corporations offer a pass-through taxation feature too and you’ll be treated as an employee of the company here.
As a result, you’ll be saved from paying the self-employment tax. But opting for this mode of taxation would mean that you’d have to pay corporate taxes.
The only condition?
You need to have 100 or fewer members or shareholders to get taxed as an S-Corporation. Additionally, these members or shareholders can’t be other Corporations, non-resident aliens, or Partnerships.
Taxation is way more stringent in the case of C-Corporations. The Corporation has to pay corporate income tax on the profits.
Additionally, all the shareholders are required to pay their personal income taxes on the profits paid to them in the form of dividends. This is frequently called double taxation and can be a burden for a small business.
While LLCs and Corporations are both great business structures, it’s important that you choose LLC over a Corporation, especially when you’re starting out. The reason for this is that small businesses often have limited resources and time.
Using a rigid and more compliance-heavy business entity like a Corporation in such a case would make it difficult for you to operate your business. Additionally, requirements like annual meetings can add to your overheads.
You would also have to shell out a lot more tax if you opt for a Corporation as you’d end up paying both personal and corporate taxes. LLCs help you reduce this tax liability through the pass-through taxation feature.
Finally, the ownership structure of an LLC is fairly simple and works extremely well for small businesses. On the other hand, Corporations are mostly better suited for bigger businesses.
Do you have any questions about why you should choose an LLC over a Corporation? Ask them in the comments section below.