Should I Form an LLC or Corporation?
Should I form an LLC or corporation? First, you should understand both business types.3 min read
Should I form an LLC or corporation? First, you should understand both business types. There are three different entities that most startups consider:
- Limited Liability Company (LLC)
- C corporation
- S corporation
An LLC is cheap and easy to set up. It costs only a few hundred dollars and meets the needs of most early-stage entrepreneurs. An LLC is a corporate entity with almost no regulatory rules to follow. You define who the members are and what percentage each member owns. If there is one sole member, he or she reports the LLC’s income or loss on his or her personal tax return.
The LLC is not taxed as a corporate entity unless it elects to be taxed that way. If an LLC has more than one member, the LLC is treated as a partnership. In this case, the LLC must file Form 1065, and each partner receives a Form K-1 that reports their particular percentage on the LLC’s income or loss.
LLCs are “pass-through” entities. The members of the LLC pay the proportional tax on the income of the LLC that is paid to them based on the LLC agreement. The LLC itself does not pay taxes on the income.
Members get the same personal liability protection as in a full C corporation. But LLCs avoid double taxation, support multiple classes of stock if needed, and are not subject to the same burdensome rules, disclosure requirements, or accounting requirements that a C corp has to follow. Plus, if and when the time comes to “convert” the LLC to a C corp, the process is not that difficult.
A C corporation is the corporation you think about when someone says “corporation.” It is an entity that is subject to federal income tax on its income. In addition, its shareholders are subject to income tax on amounts paid to them in dividends, distributions, and/or salaries.
If the C corp pays its shareholders, they pay a personal income tax on that money. The money is taxed twice; once coming into the company as the corporation’s income and once when the shareholders receive it as their personal income.
But, because a C corp is a legal entity in its own right, it gets maximum business protection. A C corp has shareholders, can issue stock to anyone, and is a respected and expected structure for most investors.
A C corp has requirements it must follow as an incorporated entity. It has to have a board of directors, and its finances and operations must also be kept in immaculately good order.
Aside from the double taxation, if you want investors to put money in your company, you should be a corporation. If you qualify for the requirements to be an S corp, that might be the best option for you.
An S corp is a C corp that’s taxed differently, permitted to do different things, and has slightly different restrictions. The “S” is an IRS classification. A C corp can elect to be taxed as an S corp if the corporation qualifies.
S corporations are “pass-through” entities. Their owners/members pay the tax on the income of the S corp that they receive based on the percentages laid out in the incorporating document. This is the same as with the LLC.
Instead, the shareholders pay the federal income tax on the taxable income of the S corporation’s business based on their pro rata stock ownership.
As an S corp, you have the same regulation as a C corp, but the tax structure of an LLC.
Unfortunately, there are restrictions on the types of investors and number of shareholders you can accept/have:
- They cannot be corporations
- They must be U.S. citizens
- No more than 75 shareholders
What to Consider
There are a number of factors to consider when trying to decide what entity you should form:
- Shall your entity have outside investors?
- When will you be seeking outside investors?
- How soon will the company be making a profit?
- How many shareholders are you hoping to have?
- How important is double taxation to you?
If you need help with forming an LLC or corporation, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.