Should I Open a Corporation or an LLC?

A corporation and an LLC are two very different entities. Both entities come with their own advantages and disadvantages; many of which relate to ownership structure, tax implications and how the business is formed.

Both LLCs and corporations also have similarities, too.

For example, both business structures offer personal liability protection, meaning owners/shareholders are protected from business debts, as well as legal action taken against the business.

Whether you choose to open a corporation or LLC, then, requires careful and diligent consideration. In the end, that choice will be influenced by several factors: the nature of the business in question; the tax strategy you intend to pursue; and how the business is expected to operate.

Below, we review the differences between corporations and LLCs along the following two lines:

  • Ownership, structure, and registration
  • Tax implications

Knowing these differences is crucial. They inform your understanding of whether a corporate structure, or whether a limited liability company, is the right, long-term choice for your business idea.

Ownership, Structure and Registration

Both corporations and LLCs must be registered as a business entity.

All states require that business entities are registered as either a corporation, an LLC or a combination of either of these formations (for example: an S corporation). However, sole proprietors are exempt from this requirement.

Even though an LLC is a limited liability company, this does not mean that corporations are not afforded liability protection. Corporations also afford owner-shareholder protection against debt and legal action taken against the business.

An LLC and corporation are structured in very different ways.

An LLC is composed of one or more persons, referred to as “members.” Members must, in accordance with state legislation, file Articles of Organization with the secretary of state as well as paying the associated filing fee.

Articles of Organization set out the fundamental architecture of the LLC:

  • Name of the business
  • Intent and function of the business
  • Official business address
  • A “registered agent” is specified; the designated member who, on behalf of the LLC, receives official legal documents
    Corporations are instead held by shareholders.

Corporate business documents are filed in the state in which the corporation operates. Each shareholder is specified a defined number of shares and a Board of Directors is established.

LLCs have a simpler structure and are less circumscribed by bureaucracy.

Corporations must hold regular meetings of the Board of Directors; those meetings conducted by taking minutes; and corporations are obliged to file various reports to the state. LLCs are not encumbered by these state demands.

Tax Implications

Whether you choose to register your business as a corporation or LLC will largely depend upon the taxation strategy you intend to pursue. LLCs and corporations are taxed very differently.

LLC Taxation

LLCs are a “pass-through” type of business – meaning that, depending on the structure of the business, profits are passed directly onto members in what is referred to as a distributive share. In addition, due to the pass-through nature of LLCs, expenses may be deducted against income.

For example: if the LLC has two members, each of which holds a 50 percent share of the company, and the LLC earns a net profit of $200,000 – then $100,000 is passed onto both members.

Both members are then taxed in accordance with their personal tax return (line 12 on Form 1040).

Corporation taxation

Unlike LLCs, corporations are not a “pass-through” type of business.

Instead, profits and losses are retained by the corporation. Shareholders are not paid directly but are, instead, issued dividends. Shareholders are then taxed based on these dividends.

One of the tax advantages of corporations is that they are not required to pay self-employment tax on profit. Instead, shareholders are only obliged to pay this tax on salary alone. Shareholders are, then, considered “employees” of the corporation and, along with paying self-employment tax on their salary, also pay FICA taxes, too.

For example: If the corporation earns $100,000 and a salary of just $20,000 is taken, the remaining $80,000 is not subject to self-employment tax. In contrast, LLCs are required to pay self-employment tax on both salary and profit.

In addition, taxation structures for corporations are more flexible. Salaries may be deducted from the corporation as an expense, thus reducing their overall tax burden.

Combining Both

It’s possible to register a business with an LLC structure, whilst opting for that LLC structure to be taxed as a corporation, what is known as an S corporation (in contrast to the traditional C corporation discussed above).

The advantage is clear: to enjoy the ownership structure of an LLC and the tax benefits of a corporation at the same time.

However, S corporations require a minimum of 100 shareholders, each of whom must be resident/citizen of the United States.

Conclusion

Whether you choose to open an LLC or corporation, then, depends upon the nature of the business, the tax strategy you intend to pursue and how the business will be operated.

Through due consideration of the factors discussed here, you may decide which approach is best for your business idea and how this decision will impact your personal financial circumstances.

Romeo Razi
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