LLC vs Corporation: Which one should I choose?
18 June, 2021
The decision of forming a company comes with many tough choices as well. The first challenge that founders encounter is choosing the right kind of business entity for their business. And out of the many business entity choices available, there are two that are considered to be one of the best - an LLC or a corporation. Both these kinds of entities have a huge advantage where they help in protecting the personal assets of the owners from any legal issues and creditors.
Normally, the creation and management of the LLC are quite easy as it is flexible as compared to the corporations. But still, each of them has its own benefits and disadvantages. Let us talk about each of them in detail to help you understand which is better for your business.
LLC vs Corporation: Which Entity Is Better?
When it comes to making a choice between the LLC and the corporation, you need to know that there is a choice in the corporation as well. There isn't just one kind of corporation. Although there aren't many differences between each, it is vital that you know all the choices that you have. So, to help you understand better, each has been explained below:
- C Corporations: C Corporation, also called a corporation is great for the companies that sell products and goods. It is for those businesses that have employees and that a storefront. Even though a few choose a corporation for their service business, many find the taxes of the C corporation too high due to the specific tax laws which are applied to the Personal Service Corporations (PSC). You can have many shareholders and even offer employee equity compensation as well. This option also helps you to make the company public easily.
- S Corporation: S Corporations are a great choice for those business owners that want to get the protection and the structure of the corporation, but will be categorized as the PSC by the IRS. It is a great choice for those startups that do not want to spend much but want to experience the best of the corporation. Unlike the C corporation, the S corporation supports the flow-through taxation, eliminating the double taxation issues (which would be explained further). But the S corporation doesn't support more than 75 shareholders and employee equity compensation plans. It also cannot be turned into a public company.
- LLCs: LLCs are not just great options for anyone but are very popular amongst most startup entrepreneurs. And the reason for this is simple - its flexibility in taxation and asset protection.
With this explained, let us pick up all the different points and see the difference in each of these business entities:
The Tax Breakdown of Each Entity
C Corporations have the widest range of expenses and deductions out of all the various entity types. And if you offer employee benefits, it just adds to the number of deductions you make to the tax paid. In addition to this, a C corporation pays an initial rate of 15% on the earning up to $50k. But even though you get a lot of deductions, you end up paying double tax on the profits earned. This means that you will be paying the corporate tax for the profits earned and after these profits are distributed as dividends, the shareholders too, have to pay the income tax on these profits.
This is a huge drawback, which is also why many choose the S corporation as it eliminates this issue. In addition to this, if you are offering services instead of goods, you will be taxed as the PSC with an initial tax rate of 35% instead of 15%. This is a step that the IRS has taken so that people do not use a corporation to pay fewer taxes for what is essentially a salary.
S Corporations were created to eliminate the double taxation issue in the C corporation, which is also why they are called the flow-through entity. This means that, in the S corporation, the company does not pay taxes at the corporate level. Taxes are paid by the shareholders on their personal income tax return forms. Although this is a great thing, the shareholders who make a lot end up paying a huge amount of tax. On the other hand, the S corporation can write off cost benefits, but shareholders that hold more than 2% of the company have to pay taxes on the benefits they get.
Moreover, S corporations are normally selected so that the owners can avoid the PSC tax rate that is applied by the IRS. This is if more than 20% of the corporation's compensation cost for its activities of performing personal services is for personal services. And these activities are being performed by employee-owners and the employee-owner owns 10% or more of the stock. Here, the personal services are the activities that are performed in the fields of consulting, architecture, actuarial science, accounting, health, veterinary services, engineering, consulting, law, and performing arts.
LLCs are very flexible in the case of taxation. They can choose how they want to be taxed. In short, they can be taxed as a C corporation or an S corporation based on their choice. It also has the choice to be taxed as a disregarded single-member entity, where the tax reporting is done on the sole owner's personal income tax return. Or they can be taxed as a multi-member partnership. No other entity has this kind of flexibility.
Asset Protection of Each Entity
C Corporations and S Corporations
In this case, both the corporation kinds are the same. Since the corporation is a separate independent legal entity from its owners, it has the most asset protection. And even though the shareholders are liable for the amount that they invested in the business, they are not at risk of losing their personal assets. This limited liability protection isn't just for the shareholders; it is also for the company's employees, officers, and directors.
There is one thing that should be noted under the asset protection of a corporation. So, in case you own shares in a corporation and then you are sued personally, then your shares in the company can be used by the creditor to pay off all the liability. So, even though the corporation helps you in keeping your personal assets safe from the corporate world and issues, your personal world doesn't keep your corporate assets safe from any personal issues that come up.
The LLC too, has personal asset protection just like the corporation. But if you are single-member LLC, then there are chances that the creditor can reach your personal assets. It is only in the states of Wyoming and Nevada where the single-member LLCs are safe from this through the charging order, where the attacker can only get your distributions from the company, else they get nothing. In addition to this, when a case comes up against an LLC, in some states, the court usually orders the sale of the assets of the business.
Shareholders and Owners
- C Corporations: C corps is the only one that allows you to have as many shareholders as you want in your company. There is no limitation on who can hold shares as well. Moreover, there are no restrictions on the kinds of shares that can be given out. In short, if you are planning to go public at some point in time, then the C corporation is a great choice.
- S Corporations: S corps have a lot of restrictions as compared to the C corporation. All the S corporation shareholders have to be US citizens and you can have only a single type of shares issued in the company. The number of shares is also restricted.
- LLCs: In an LLC, shares are not issued. But the LLC can have many owners who own share a percentage of the company. An LLC cannot go public at all.
From the above, you now know what are the differences between both the LLC vs the corporation. You can now make your choice based on how you want to run your company. Both are great choices, you just need to see which will be better for your company and its future. And once you make your decision, you can then move ahead and get your company incorporated.
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