Deborah Sweeney of MyCorporation.com answers a frequent question from small business owners, about the type of business they should form.
QUESTION: I’m trying to decide which entity I want to file my new business as — what’s the difference between a corporation and a limited liability company?
ANSWER: Let’s start with a corporation. The major benefits that come along with forming a corporation are liability protection, the ability to issue shares or stock options, and the fact that only salaries are subject to taxation. The major benefits of forming an LLC include an easy start-up process, an overall simple management structure, pass-through taxation (meaning taxes flow through to your personal tax returns), liability protection, and the fact that it’s also less expensive to start than a corporation.
Both entities keep a line drawn between personal and professional assets. If you want to ensure more formalities within your business (some investors, for instance, might require this), forming a corporation is the way to go. Corporations require annual meetings and minutes, and have shareholders and directors in place for long-term management. If you’re looking for more flexibility in terms of business organization and management, an LLC may be right up your alley. It’s also a bit easier to run than a corporation, as fewer formalities are required.
[Related: Read Deborah’s post on How to Form an LLC.]
But how do you really know which business formation is the “best” one?
Much of this ultimately boils down to the type of business an entrepreneur decides to run. An entrepreneur that wants to branch off into opening multiple locations will likely choose a different type of entity than someone who wants to run an e-commerce storefront strictly online.
However, the question still remains the same. Do I incorporate my business? Should I form an LLC? Or, should I choose another entity entirely? Let’s take a more in-depth look at the options available to entrepreneurs.
If an entrepreneur’s end game is to grow and expand the business significantly, incorporating is the way to go. Much like with an LLC, forming a corporation provides liability protection for the separation of professional and personal assets.
However, unlike LLCs, corporations are a significantly less flexible entity. Corporations do offer perks to outside investors, like angel investors and venture capitalists, by way of issuing shares and stocks. However, running a corporation means observing certain formalities. Shareholders and directors must be appointed in place for long-term management purposes. Annual meetings are required, as are the taking of minutes during said meetings.
Then, there’s the tax aspect. Corporations are subject to double taxation, meaning the income is taxed first at the corporate level, and then again at the personal level when it’s distributed to members as dividends. For that reason, you might want to consider another major entity: S Corporations.
Here’s the skinny on S Corporations, an entity that could be wildly confusing if it isn’t broken down bit by bit. S Corporations are famous for being a “pass-through” tax entity. They begin as LLCs, and file for S Corp status with the IRS. This filing is often chosen by entrepreneurs, who may choose to file their business taxes as an S Corp after forming a corporation or LLC. What’s in the name? The “S” part of “S Corporation” is drawn from subsection “S” of the tax code.
Still with me? Good! Now that you’ve filed for S Corp status, you’re essentially telling the government that you would like your business to be taxed as a partnership. This allows your business to avoid double taxation.
Once you’ve been formally approved, an S Corp allows entrepreneurs to have profits, losses, deductions, and credits “pass-through” the entity level. Now, they’re going directly to the business owners’ personal tax returns. It’s that pass-through motion that keeps you from being taxed double, helping to save a lot of money in the process.
[Related: More advice and tips for women entrepreneurs]
Limited Liability Company (LLC)
Let’s sum up its basics.
LLCs are entities that allow business owners to separate their personal assets from their professional ones using liability protection. This kind of safeguard in place keeps your personal belongings from being impacted by any negative business issues. Imagine that your small business was served with a lawsuit. Forming an LLC would ensure that your personal assets, like your house and car, are kept safe with liability protection.
Forming as an LLC also affords entrepreneurs with more flexibility to run the business. Its structure even allows entrepreneurs to consider operating the LLCs as either a member- or manager-managed LLCs.
A member-managed LLC is a fairly common choice for a small business owner who still wants the ease of running the business but may have limited resources to do so. A member-managed LLC is basically the tribe of the LLC entity landscape. Every member is treated equal and shares responsibility for the LLC’s daily operations.
Manager-managed, on the other hand, has a board of managers. This is the LLC equivalent of a corporation’s board of directors. These managers have more control than other members and work on the direction and operations of the LLC. Small business owners that struggle with taking on too many duties may consider utilizing the help that managers provide in a manager-managed LLC.
Wait! Which entity should I file as again?
I’ve kind of left you with a cliffhanger here, huh? Truthfully, I can’t tell you which entity is the best fit for your business. You might read through this post and determine that you fit into one of these entity types. Or, you may find you’re none of the above. Maybe you’re meant to be a sole proprietor or a B Corporation or even a 501(c)(3) nonprofit organization. If you’re truly in doubt, meet with a legal professional. They can assist you in determining the entity, and tax filing, that is the best fit for your business.
Got a question for Deborah? Ask it in the comment section.
Deborah Sweeney is the CEO of MyCorporation.com which provides online legal filing services for entrepreneurs and businesses, startup bundles that include corporation and LLC formation, registered agent services, DBAs, and trademark and copyright filing services. You can find MyCorporation on Twitter at @MyCorporation.
[Related: How Do I Add a Partner to My Business?]
Posted: December 17, 2018