Forming a Corporation vs. LLC
This article is designed to help you figure out whether a corporation or a limited liability company (LLC) is best for your business. Which one is going to be better for your business? Which one will be easier to create and maintain? Although this article cannot give you a firm answer one way or the other, it will attempt to show you the advantages and disadvantages of both corporations and LLCs.
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Is an LLC Right for You?
Many small businesses may find that the flexibility and simplicity of a LLC makes it the better choice when it comes to forming as a corporation versus an LLC. If you plan on your business owning property, you will seriously want to consider forming your business as an LLC to avoid the problem of double taxes.
This issue may crop up if the business is formed as a corporation. This double tax problem arises if the business owns property that appreciates in value and the business is formed as a corporation.
When this happens, both the corporation and the shareholders are taxed by the increase in property value when the property is sold or when the corporation is liquidated. Owners of an LLC, however, avoid this double taxation problem because the business' taxes are "passed-through" to the owners of the LLC, meaning the LLC is not a tax entity in itself and does not pay taxes on its income.
Is a Corporation Right for You?
There will often be factors that make a corporation (C Corporation) the better choice when it comes to the corporation versus LLC decision. These factors could include:
Large Number of Investors or you Plan on Raising Money from the Public
- Although LLCs work great when there are only a few owners of a business that expect to have a hand in the dealings of the business, the LLC structure starts lacking when the number of investors and owners increases. At some point, the investors will want to have some sort of tangible ownership right in the business, which is where stock certificates come in. You can only issue stocks if you have organized your business as a corporation, however.
Providing Benefits to Owners
- Corporations are often able to provide benefits to those that are both employees and investors in the business. For example, if a person is both a shareholder of a business, and is also employed as the business' chief financial officer, the corporation would be able to pay that person a salary and also provide benefits like health insurance.
- Because of the setup of a corporation, the business will probably be able to deduct the costs of the health insurance from its profits, and the benefit provided to the employee is not considered income. This is a great benefit of forming your business as a corporation. To contrast, an LLC can only deduct a portion of the cost of the health insurance (and other benefits) premiums paid for the employees.
Retaining Good Employees.
- Unlike a LLC, a corporation has a great incentive system built directly into the structure of the business that can help small business retain great employees. Corporations can offer their best employees stock options that, in addition to providing an incentive for employees to remain with a business, also provide an incentive for an employee to continue working diligently for the business. Offering these stock options is an easier way to get employees a membership interest in the business, unlike LLCs where it can often be difficult and complex to get employees into the membership circle.
Is an S Corporation Right for You?
Under an S corporation, you only pay self employment taxes on money you receive as compensation for your services, not on the profits that pass through the corporation to you. To make this clear, suppose you get $80,000 from your S corporation for the year, $60,000 of which was compensation for your services to the corporation. You will only pay taxes (15.3 percent) on the $60,000, not on the additional $20,000.
If your business were formed as a LLC, however, you may have to pay self employment taxes on the entire amount of business profits that pass through to you automatically.
Get Legal Help Understanding the Difference Between Corporations and LLCs
As you can see, corporations and LLCs each have their own advantages and disadvantages. Whether you're considering forming a corporation or an LLC, it's best to contact a business organizations attorney if you have questions. Then, work with a lawyer or reputable business formation service to set up your business