Are LLCs Corporations: Everything You Need to Know
Are LLCs corporations? Not counting sole proprietorships and partnerships, the least complicated business structure is an LLC. 3 min read
Are LLCs corporations? Not counting sole proprietorships and partnerships, the least complicated business structure is an LLC. It is flexible in many ways and has several benefits, such as separating your personal assets from business assets and allowing business profits to pass through to business owners. Whether it's right for your business or not depends on your own goals for the business, your preferences, and the preferences of the business's other owners, if any.
LLCs have similarities to corporations, but they are not the same. LLC stands for “limited liability company,” not “limited liability corporation,” as many people think. LLCs have only been around since the 1970s and were created as an entity that takes on characteristics of both sole proprietorships/partnerships and corporations.
As a relatively simple structure, an LLC costs less to start up than a corporation. Although an LLC can do business in multiple states and even different countries, it is formed in a single state. If it has business locations in different states, it may register to do business in those locations as well. LLCs must file annual reports in every state where they are registered.
Incorporation, on the other hand, may seem overwhelming to a new business owner. A corporation is a business entity that is separate from the people who founded it. Business owners need to decide whether they want to set up an S corporation or a C corporation. Both offer similar benefits, but also have their own advantages and disadvantages.
The biggest difference between S corporations and C corporations is the way they are taxed. S-corps are “pass-through” in terms of taxes, just like an LLC. On the other hand, C-corps are taxed directly on their own earnings -- which can lead to double taxation for shareholders, who must pay income taxes on their dividends, or distributions.
LLCs do not pay taxes themselves. Instead, profits and losses are passed on to the owners, who are called members. They in turn must report this income on their own personal tax returns. An LLC can elect to be taxed as an S corporation, but this does not turn it into a corporation.
What Are the Advantages of an LLC?
S corporations have several restrictions. For one thing, S corporations can have no more than 100 owners. Owners must be U.S. citizens or live within the U.S. Conversely, there is no residency requirement for LLC owners.
- LLCs offer legal protection for owners' personal assets, which does not exist with sole proprietorships or partnerships.
- LLCs may seem more respectable and credible than sole proprietorships or partnerships, encouraging lenders, investors, vendors, and other partners to do business with you.
- LLCs are flexible in terms of management and relatively easy to set up.
- LLC owners, called “members,” simply set up an operating agreement stating the percentage of ownership each has within the business. On the other hand, in a corporation, this is done by distributing shares of investment.
- LLCs do not require a board of directors with regular meetings, recorded meeting minutes, and annual reports.
- LLCs are allowed to use the cash method of accounting, in which income will not be counted as having been earned until it is actually received. Corporations must use the accrual method of accounting.
- LLC members can deduct losses associated with operating the business against their income, to some extent.
Are There Disadvantages to an LLC?
An LLC business structure is not best for every company. Some of the disadvantages, as compared to corporations, include:
- LLCs cannot sell stock to shareholders to raise operating capital or fund expansion.
- C corporations can issue different types of stock, such as common and preferred, which allow for different levels of investment and dividends.
- LLCs may not be treated the same way in different states.
- Members of LLCs must pay self-employment tax on their earnings.
- Even if profits are reinvested in the company, LLC members are immediately taxed on their share of those earnings.
If you are in the process of deciding which business structure is right for your business, you should consult with an attorney who is familiar with LLCs, corporations, sole proprietorships, and partnerships. A CPA can also help you regarding the tax implications of each choice.
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