One of the very important decisions that you as a new business owner or an entrepreneur have to make is to choose the right legal structure for your business. You might have heard about various types of business entities such as LLCs, corporations, S-corp, C-corp, etc., but do you really know the key differences?
In this guide, we will discuss the main differences between an LLC and a corporation in terms of profitability, flexibility, the way they are organized, taxed, etc. By the end of this guide, you will have all the basic information regarding the two business structures.
What Is a Limited Liability Company?
Let us begin with the Limited Liability Company (LLC). An LLC is a type of legal business entity that separates your personal assets (home, bank account, car) and liabilities to ensure complete protection in the event of a lawsuit filed against you.
Read more: Learn how to form an LLC in your state
With its own EIN (Employee Identification Number), the members of an LLC are able to open a separate bank account under that LLC’s name while safeguarding their personal assets and liabilities at the same time. Other business types such as sole proprietorship or partnership do not give you personal asset protection.
What Does Pass Through Entity Mean?
In business context, a pass-through entity is a legal setup where business owners are taxed on the profits or salaries they receive from the company as personal income, instead of the company having to pay taxes in the form of corporate income tax.
LLCs are pass-through entities, which means that business profits are passed through to the member(s) of the LLC.
Single-Member VS Multi-Member
If the LLC is owned by a single person, it is called a single-member LLC, and if it is owned by more than one member, it is referred to as multi-member LLC. There is a difference the way LLCs are taxed depending on which of these types the LLC is registered as.
IRS treats single-member LLCs as sole proprietorship which means that the organization will not have to pay the taxes. However, that member will pay taxes and file tax returns with the IRS.
Multi-member LLCs are treated as a partnership, which means the LLC will not pay the taxes. However, all members will be subject to taxation according to their agreed share of profits earned from the business.
Who Should Go for an LLC?
If you do not wish to put your personal assets at risk, LLC is the legal structure that you should opt for. The ‘protective wall’ that you get through personal asset protection is one of the major reasons why new business owners and entrepreneurs go with this option.
Moreover, if you do not want to elect a board of directors for your business, don’t need those board meetings along with maintaining the records of those meetings, do not want to be taxed twice — LLC is what you need.
New business owners who anticipate small profits or even losses in the initial stage of their startups, should go with an LLC as this type of entity gives you a better tax mechanism even if you incur losses for a specific time period. Also, it is relatively easier to dissolve the company without going through a lot of legal procedures.
In short, LLC is considered to be the most flexible business setup for new business owners and entrepreneurs.
What Is a Corporation?
When you see an organization name that ends with ‘Inc.’, it is a corporation. This is a type of business structure that allows legal separation and distinction of an organization from its owners.
This means that, just like an LLC, personal assets and liabilities are kept separate from the business. Corporations can borrow loans, enter into contracts, file lawsuits or have lawsuits filed against them, buy and own assets, hire employees and be taxed.
Whenever you hear the name of big groups such as Apple, Walmart, Amazon, etc., you should know that they are all corporations.
Mechanism of Taxing Corporations
There are two types of corporations — the S-corp and the C-corp.
C-corp business entities are taxed on taxable income that is separate from what is paid to shareholders or the owners of the organization. When profits are shared between owners then they are taxed again and those profits are considered as dividends.
The ongoing corporate income tax rate for a C-corp business entity is 21%, which previously used to be 35%.
S-corp entities follow a tax mechanism that is similar to an LLC. Here, the net income or loss passes through to the owner and the owner is treated as a sole proprietor. Dividends distributed to the company’s shareholders are not taxed, but the shareholders are usually treated as the company’s employees and are subjected to employment tax through their W-2 compensation.
Who Should Go for a Corporation?
If you are planning to initiate your business at a large scale, a corporation can work well for you as it allows you to have shareholders who can raise substantial financial capital for your business.
Moreover, electing a board of directors and having regular meetings with your company’s directors can result in better governance both in the short and the long run.
It is also a better option for you as a entrepreneur or a new business owner if you are considering going public with your business sooner rather than later.
Can You Opt for Both Types at Once?
There is no legal way to register your business as both LLC and Inc. at the same time. However, as per your business needs or in line with your organization’s gradual growth over the years, you can change the legal entity of your business.
To change the legal status from an LLC to that of a corporation, Form 8832 (Entity Classification Election) needs to be submitted.
Similarly, to change a corporation to an S-corp, Form 2553 (Election by a Small Business Corporation) needs to be completed. This will allow your business to be taxed like an LLC (individual members will be taxed instead of corporate tax being charged against the business).
LLC VS Inc. — Our Final Thoughts
By now, you must have a better idea about the key differences between an LLC and an Inc. If you are an entrepreneur planning on a small business startup with a lot more flexibility, LLC is the way forward.
If you are looking to go big scale right from the word go with investors and shareholders raising capital for you, registering your business as a C-corp or an S-corp will work better for you.
