If you’ve ever considered starting a business, then you know that selecting the type of entity can be very confusing. When you’re new to entrepreneurship, it can feel overwhelming as you research and try to understand entity structures. While there are many options, most people face one burning question … What’s the difference between a Limited Liability Company and a Corporation?
Let’s take a moment to explore the differences between these entities and the benefits you can get from each structure, including the disadvantages and advantages.
Selecting the correct business entity is your giant first step into being an entrepreneur. It’s your foundation for start-up, but also your platform for growth. Your entity will help you set the stage for how your business functions on a daily basis, as well as how it expands over time. As you research your decision, start thinking about the protection you want and the advantages you need to be successful.
Let’s start with Limited Liability Companies.
A Limited Liability Company is just that – it protects you, as the business owner, from being held personally liable for the actions of your business (or the LLC). If there is a lawsuit against your business, the LLC protects you from the personal risks. This means that your personal assets stay safe. Additionally, LLCs have other benefits.
- LLCs offer pass-through taxation, meaning that taxes are not paid at the business level. When you create an LLC, income and losses are reported on your personal tax return. When taxes are due, they are paid on the individual level.
- LLCs provide flexible management structures, allowing you to take control of daily operations and long-term growth strategies. Corporations have a predetermined management structure where directors supervise the essential business decisions, while officers take on running daily functions of the business.
- LLCs face fewer compliance requirements than corporations, as well as fewer state-imposed annual requirements and ongoing formalities.
With all of the great benefits of an LLC, there are still some disadvantages to explore, as well.
- LLCs have higher ongoing expenses through state filing fees, annual report and/or franchise tax fees, and some states even require owners to publish notice of the LLC formation in the local newspaper.
- Ownership is more difficult to transfer in an LLC, since typically all owners must approve the changes or ownership addition. Corporations utilize shares of stock to manage ownership.
- Because LLCs are a newer type of business structure, there is less legal precedent for this entity type.
Now let’s take a look at corporations.
One of the most important points to understand about LLCs and corporations is the tax structure. S-corporations operate like an LLC with pass-through taxes. However, C-corporations are taxed separately, and also subject to double taxation if corporate profits are distributed to owners as dividends. C-corporations pay taxes through their profits as a corporation and then individual owners pay taxes separately on profits received as dividends. This tax that is paid on two levels, is referred to as double taxation.
There are additional useful differences to note regarding these two entity structures:
- S-corporations have restrictions regarding the number of owners, the type of owners, and who/what can own it.
- C-corporations give owners the ability to hold different types of stock interests, providing various levels of dividend payouts.
- If you incur business losses, S-corporations allow owners to use the losses as deductions on personal tax returns.
- S-corporations can help save money on self-employment or Social Security/Medicare taxes. Owners have the ability to offset non-business income with losses from the business.
It can be difficult to decide the best entity for your business, but doing your research ahead of time can definitely help you make an educated decision. When you’re in doubt, it’s important to seek legal advice to start your business on the right path to success.