What is better LLC or corporation? An LLC offers the limited liability of a corporation combined with the management methods of a partnership. On the other hand, a corporation receives many special tax advantages but also is subject to double taxation.

Choosing Between a Corporation and an LLC

The straightforwardness and flexibility provided from an LLC make it an ideal business structure for many small businesses. Companies that have invested in property and other investments and are likely to appreciate in value will benefit from organizing as an LLC.

Shareholders that have invested in a C corporation will be subjected to double taxation because they will pay taxes as both a stockholder and as an individual. An LLC is known as a "pass-through entity." In this format, net profits or losses from the business are pushed down to the owner level where they are recognized on the personal tax returns of the members. This pass-through status ensures that LLCs avoid paying double taxation.

Complications may arise for LLC members as the total sum of new investors expands. For example, potential investors may require that they hold physical/tangible stock certificates in the business. When situations like this occur, it may be easier to structure the organization as a C corporation.

In most states, it only takes one member to organize as an LLC. If a company is organizing in California, Massachusetts, or the District of Columbia, they must have no less than two members. Please keep in mind that a spouse will meet the requirement of two people. If you're unable to meet this requirement, you'll have to incorporate as a C or S corporation.

Individuals that incorporate will most likely be both an employee and owner of the corporation. This tax structure allows shareholders to deduct a wide range of expenses. As an employee of the business, your salary, insurance premiums, medical expenses, and other fringe benefits may be deducted from the income of the business. These tax-favored benefits are slightly reduced when organized as an LLC.

Additionally, a corporation will be able to offer a retirement plan that is more comprehensive than the typical LLC.

Choosing Based on Taxes

Taxes are always withheld from an employee's paycheck. In 1998, it was required that employers deduct 7.65 percent of the amount up to $68,400 for Medicare and Social Security taxes, and an additional 1.45 percent above that threshold. The employer was then required to add an identical amount and forward both amounts to the IRS. Self-employed individuals are responsible for paying the same total percentages as the amount sent by the employer.

S shareholders that are also employees will only pay self-employment taxes on the compensation received for their services rendered. They will not pay self-employment taxes on the profits of the organization.

Future IRS guidelines suggest that the profits of the LLC will be charged self-employment tax when the member:

  • Spends over 500 hours per year participating in the business
  • Works in one of the following fields:
    • Health
    • Law
    • Engineering
    • Architecture
    • Accounting
    • Actuarial science
    • Consulting
  • Authorizes contracts for the LLC

Until this rule is clarified by the IRS, assume that each member's income will be subject to self-employment tax. For now, an LLC member will pay more self-employment tax than a shareholder in an S corporation. Business owners will need to determine if these tax savings are substantial enough to outweigh the benefits of organizing as an LLC.

What Is Incorporation?

When a business is incorporated, it evolves from a general partnership or sole proprietorship into a corporation that's legally identified by the state of its incorporation. Separate from the owners who initially founded it, the business is now established as a legal entity of its own. The new structure of the business will now either be classified as a corporation or an LLC.

Limited Liability Company Benefits

Some of the benefits of an LLC include:

  • Personal limited liability protection
  • Flexibility in how the business is managed
  • Pass-through taxation
  • Meeting minutes are not required
  • Members do not need to be U.S. citizens or permanent residents
  • The ability to easily add investors without impacting the overall business structure

Advantages of a Corporation

Some of the advantages of a corporation include

  • Splitting the income may lower tax liability
  • The ability to raise capital by selling shares of stock
  • Personal limited liability
  • Special tax benefits
  • Perpetual life
  • The business can run independently from its shareholders
  • S corporations are not subject to federal income tax

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