Corporations versus LLCs
You have the business idea and the determination to become an entrepreneur. Yet before you even place the open sign on your business doors, you must decide what type of business you want to operate: a corporation or an LLC.
The Basics of Corporations and LLCs
Understanding the basics of each business type allows you to select the right one that will fit into your business management and tax strategies. As a small business grows, it can often change business types to suit different management and financial situations. Be aware that you do not have to be locked into one type throughout the life of your business, according to FindLaw.
Corporations are legal entities of their own. Through a corporation, you are able to sell stock offerings to people who will become shareholders and have ownership. From selling the stock, you can gain investment capital that can assist with operating and expanding your business, according to the Small Business Administration.
Corporations take on all liabilities related to the business, whether it is business debt or actions the business commits. These liabilities will not affect your personal assets.
When you incorporate, you will be double taxed. First, the IRS taxes profits to the corporation. Then the IRS taxes dividends that the shareholders receive from the corporation. Corporations have very complex tax regulations and record-keeping operations, so take this into consideration to prevent committing tax fraud.
Benefits: Business liability protection, raise investment capital from selling stock
Drawbacks: Double taxes, extensive record-keeping costs
Limited Liability Companies, known as LLCs, are a type of hybrid business structure that combine all the benefits of a corporation with the benefits of a partnership. When you own an LLC, you become a member. You can have as many members as you wish, as these members may be corporations, individuals, or other entities. Some states require the LLC to dissolve if a member leaves the business.
There are no stocks to sell with an LLC, so you may raise money in different ways such as requiring new members to invest a set amount into the LLC, or seeking debt financing in the form of bank loans or government loan programs.
LLCs have the same business liabilities as corporations. Your personal assets can’t be touched if someone sues the LLC or if the actions of the LLC cause the business to make reparations. An important advantage of the LLC is that the IRS does not double tax it like a corporation. Instead, you acquire all debts and earnings, which will be placed on your personal income tax returns. All members of the LLC have to file under self-employment status, as all net income becomes taxed.
Benefits: Business liability protection, profit and cost sharing to members
Drawbacks: Self-employment taxes, business may have to close if a member leaves
Questions to Ask When Deciding Between the Two
When debating about being an LLC or a corporation for your small business, ask these important questions:
- What costs more to establish and operate? Typically an LLC is easier to start and operate. Corporations cost more to start and have stringent record-keeping requirements.
- How do you want to handle your tax obligations? While a corporation has certain tax benefits, the double taxation can be seen as a major detriment.
- Where do you want to gain financing? Corporations allow you to raise money by selling stock options. You cannot do this for an LLC, although there are other financing options available.
- What do you expect to happen to the business in the future? An LLC can have a limited lifespan if a member leaves. A corporation can last a lifetime.
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