So you say you want to start a business? Great. Now it’s time to begin planning.
One of the most important decisions you will need to make is what type of business you want to own. From the moment you begin making sales “as a business”, you will need to choose a business structure and create a corresponding business plan.
Two of the most common types of businesses are LLCs and corporations. In this article, we will explain everything you need to know about establishing these types of businesses. By taking the time to understand their differences, advantages, and disadvantages, you’ll be able to decide which type of business is right for you.
LLC vs Corporation: Key Differences
The primary difference between an LLC and a corporation is that while an LLC is owned directly by the owner(s), a corporation is owned by the shareholders. This makes corporations ideal for businesses that anticipate heavy outside investment. LLCs will often get loans and other forms of financing from outside parties, but this is much different than outside ownership.
What is an LLC?
LLC is an abbreviation that stands for “limited liability company.” An LLC is a simple business structure that allows the owner, or owners, to separate their business expenses from their personal expenses.
To many people, an LLC is a “combination” of a sole proprietorship and a corporation. An LLC is like a sole proprietorship (or partnership) due to the fact that it functions as a pass-through tax entity and, at the same time, it is also like a corporation due to the fact that it limits the owner(s) personal exposure to liability.
Generally speaking, an LLC is the simplest type of registered business. LLCs, when compared to other types of businesses (like corporations), are relatively easy and affordable to create and establish. However, if the owners of the business are looking for outside ownership, they may consider creating a corporation.
What is a Corporation?
Like an LLC, a corporation is a business entity that is legally separated from its owners. The defining characteristic of a corporation is that it is owned by the shareholders. Some corporations (a small fraction) are publicly traded and can be bought or sold on platforms such as the NYSE, NASDAQ, and others.
Corporations are created to help owners limit their exposure to personal liability, as well as potentially minimize possible taxes. The shareholders of a corporation can enjoy payouts, which typically come in the form of dividends and asset appreciation, without being held personally liable for any of the company’s debts or outstanding liabilities.
Relatively speaking, corporations are considered more complex and “formal” than LLCs. However, contrary to what many people might initially assume, corporations can be very small and can still have as few as one owner (someone who holds 100 percent of available shares).
Types of Corporations
There are two primary types of corporations: C corporations and S corporations.
C Corp
C corporations (C Corp) are the most common types of corporations. The establishment of the corporation creates an entity that is legally distinct from the shareholders and the entity is fundamentally treated like a “legal person.” C corps often have many owners. C corps are subject to two rounds of taxation on all profits: the corporate income tax applies to the company’s profits, while personal or capital gains taxes apply to each of the shareholder’s personal dividends and earnings.
S Corp
An S corporation is a corporation that can potentially avoid corporate income taxes, but must also have 100 or fewer owners. Effectively, S corps are taxed the same as partnerships (meaning they’ll have only one round of taxation). Like a C corporation, S corps—which are filed under “subchapter S”—can pass income and losses onto shareholders. The income or losses are then treated as personal income. Only some corporations can qualify to become S corporations, which is why they are less common.
Taxes: LLC vs Corporation
When deciding whether an LLC or a corporation makes the most sense for your business, one of the most important things you’ll need to consider is taxes. The business structure you choose can affect how you are taxed, when you are taxed, as well as the rate you are taxed.
LLC Taxes
Creating an LLC can help you enjoy the limited liability of a traditional corporation, without the need to pay corporate taxes. Avoiding corporate income taxes can have a very positive impact on your business’s bottom line. However, owners of an LLC are usually legally considered self-employed, meaning they will need to pay an additional self-employment tax for social security and Medicare.
Corporation Taxes
C corps will be subject to corporate taxes. Because of this, c corps are generally considered the most expensive type of corporation, but they do offer the broadest legal distinction, liability protection, and access to outside capital. Furthermore, dividends and capital gains are taxed differently than personal income, which can potentially help shareholders limit their personal tax liabilities.
S-Corporation Taxes
Many people consider that the S corp is the perfect compromise between an LLC and a C corp. Unlike most LLCs, shareholders in an S corp can avoid the somewhat high self-employment tax. At the same time, S corps can avoid paying corporate income taxes. However, an S corp is not nearly as flexible as an LLC, and not every business can qualify for S corp status.
Business Ownership: LLC vs Corporation
While an LLC will be owned by the owner(s)—someone who has the legal claim to the company’s balance sheet assets—corporations are owned by the shareholders, individuals that have claims to the company’s assets. While this distinction might seem small, it can be very important when it comes to dividend collection, wealth accumulation, and solvency.
What are the Major Advantages and Disadvantages of an LLC?
When compared to other business structures, LLCs offer several distinct advantages.
- Flexibility
- Simplicity
- Affordability
- Reduced exposure to liability
- No corporate taxes
However, there are also some drawbacks to choosing to create an LLC
- Self-employment taxes
- Difficulty accessing capital
- Less “formal” than a corporation
