When it’s time to incorporate, many small business owners find themselves wondering which business type to choose. Gaining a clear understanding of your options can feel overwhelming, especially if you’re just getting started. Let’s take a look at some consideration points when comparing LLC vs. corporation options. But first, let’s start with a quick definition of what it means to incorporate.
What is incorporation?
When you incorporate a business, you evolve from a sole proprietorship (or general partnership) into a company that’s formally recognized by its state of incorporation. In other words, it becomes a legal business entity of its own — separate from the individuals who founded it. The new company structure often falls into two categories: a limited liability company (LLC), or a corporation (corp). In this article, we’ll be focusing on LLCs, as well as two popular types of corporations — an S corporation (S corp) and a C corporation (C corp).
No matter how you choose to incorporate, there are certain benefits you can expect — like being shielded from personal liability, as well as increased credibility with customers. There are also additional advantages and disadvantages associated with each incorporation type.
LLC vs. corporation: What’s the real story?
All incorporation options are not created equal. When deciding between a corp vs. LLC, the best choice for your business not only helps you start off on the right foot, but also acts as a foundation for your company’s ongoing success and growth. As you consider which business type is right for you, thinking both about your short and long-term goals for your company is advisable.
Limited liability company benefits
LLCs protect business owners, also referred to as members, from being held personally liable for the actions of the LLC. This limited liability typically protects you from the personal risks involved if a lawsuit were to arise concerning your business — safeguarding your personal assets. A couple additional benefits of an LLC include:
- Flexibility in management. Corporations have a set management structure where directors oversee the major business decisions and officers are responsible for the day-to-day running of the business. LLCs do not have the same formal management structure.
- Pass-through taxation. With pass-through taxation, taxes are not paid at the business level. If you choose to become an LLC, income/loss would be reported on your personal tax return. If any taxes were due, they would be paid on the individual level.
To learn more about LLCs, visit our Benefits of Creating an LLC article.
When evaluating types of corporations, many business owners consider taxation to be the most noteworthy difference between S corporations and C corporations. In a nutshell, an S corp is a “pass-through” tax entity, like the LLC. In contrast, C corps are taxed as separate entities. They are also subject to “double taxation” if corporate profits are distributed to owners (shareholders) in the form of dividends. C corporations pay tax on their profits first at the entity level and then owners pay taxes at the individual level on profits received as dividends, resulting in the double tax.
LLC vs. corporation: Other key differences
We’ve already noted taxation and management as two distinctions between limited liability companies (LLCs) and corporations, but there are other key differences worth highlighting, including:
- Business losses. The "S corporation advantage," allows business owners to use business losses — like those incurred during the startup phase — on their personal tax returns as deductions.
- Self-employment taxes. An S corp can provide savings on self-employment or Social Security/Medicare taxes, and it allows owners to offset non-business income with losses from the business — unlike a C corp which is a completely separate tax entity.
- Ownership restrictions. Neither the LLC nor the C corporation have restrictions on the number of owners the business can have or who can be an owner. S corporations, however, have a number of restrictions. S corporations can have no more than 100 owners, and owners cannot be “non-resident aliens.” Additionally, S corporations can not be owned by C corporations, LLCs, other S corporations or non-qualified trusts.
- Dividends and venture capitalists. C corps are often the preferred incorporation choice of developing businesses. Owners can hold different types of stock interests (including preferred and common stock), which allow for different levels of dividends. This is one reason why venture capitalists choose C corporations when they offer funding to a business. Investors are attracted to the prospect of dividends (often higher dividends) if the corporation makes a profit.
- Earnings. C corps can retain and accumulate earnings (within reasonable limits) from year to year.
Making your choice
Need more tools to decide between an LLC vs. corporation? Our Incorporation Wizard compares multiple business types based on the specific contingencies you enter, and our Business Type Comparison gives you an at-a-glance snapshot of how different business types compare on different characteristics. Of course, for questions specific to your particular situation, it is best to seek the advice of an attorney or accountant.
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