LLC vs Corp: Everything You Need to Know
When comparing LLC vs. corp, you'll want to understand each one's major differences and similarities to determine how to best structure your company. Look at the details and small distinctions between each of these business formations.3 min read
When comparing LLC vs. corp, you'll want to understand each one's major differences and similarities to determine how to best structure your company. Look at the details and small distinctions between each of these business formations.
Because these two entities can be complex and difficult to understand, you might want to get advice from an accountant or a lawyer. Not all professionals, however, are familiar with the current laws about limited liability company (LLC) formation in your state. When you find someone who does understand these laws and their differences, he or she can help you determine whether forming an LLC or a corporation will be the best option for your business.
Tax Entity vs. Legal Entity
It's important to understand the difference between a tax entity and a legal entity. Limited liability companies and corporations are legal entities, while partnerships, sole proprietorships, S corporations, and C corporations are tax entities. Many new business owners don't understand the differences between these concepts and end up getting confused.
A tax entity is a classification under the IRS and state tax agency. It defines the way these agencies view the business. A legal entity is how all other legal parties, including contractual partners, courts, and the state agencies, will view the business. A corporation is a legal entity, but its tax entity designation will be as either an S corporation or a C corporation.
An LLC is a legal entity, but its owner(s) can choose from several tax entity options. Limited liability company isn't a tax designation, but its taxation options include treatment as:
- A sole proprietorship
- A C corporation
- An S Corporation
- A partnership
Because it has more options, an LLC is more flexible in terms of taxation. Therefore, the owners, called members, can decide which offers the most benefits.
While LLCs have flexibility for taxation, corporations have none. One of the drawbacks to forming a corporation is double taxation. This means business profits are first taxed at the corporate level and then again on the dividends paid out to shareholders. S corporations have pass-through taxation, which eliminates the double tax requirement, but not all businesses qualify as S corporations. Depending on a company's circumstances and legal structure, its only choice might be to form a C corporation.
Regardless of how an LLC is organized or structured, it can choose its taxation. By default, LLCs are pass-through tax entities, which means double taxation does not apply, but the members can elect for treatment as an S corp or a C corp if either designation is applicable. Entrepreneurs might not want to form a corporation due to the double taxation requirements, but in some cases, electing for treatment as a C corporation can be a better financial decision. However, for many businesses, this isn't the best choice.
When a company does qualify as an S corp, the taxation differences between S corps and LLCs aren't as significant. Both offer pass-through taxation. One of the main differences comes in the form of profit distribution. Dividends distributed to an S corporation's shareholders aren't subject to employment tax, while profits distributed to an LLC's members are subject to that tax.
Small businesses can avoid major employment tax regulations by electing for treatment as S corporations. However, some drawbacks can make this election a poor choice, so it's important to talk to a professional who understands the differences before making a decision. More paperwork and less flexibility are two examples of drawbacks to forming an S corporation.
In an LLC, the business owners are called members. In a corporation, the owners are called shareholders. The names are different, as are their responsibilities and ownership requirements. For example, an LLC can distribute as much ownership stake in the business as the members wish, regardless of the capital contributions each member makes.
The ownership stake distribution is especially important when considering how the company will distribute profits among its members. If the LLC's operating agreement outlines equal shares of the profits to all members, this means a member that didn't necessarily invest as much as another will receive the same amount of money.
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