Perhaps this is the year you’ve decided to take your business to the next level. Your colleagues may have mentioned forming an LLC or even starting a corporation. So fancy. But what’s the deal with each? And what do you need to know to decide between an LLC vs corporation?
Before you pick one, you owe it to yourself and your company to carefully consider your current needs, and how those might change over the next few years. In the battle of LLC vs C Corp, the answer really lies in the future details. Here’s what’s up with each and how it may affect your business down the line.
What’s an LLC?
LLC stands for “limited liability company.” Be careful of anyone who tells you it’s a “limited liability corporation.” There’s no such thing.
To form a single-member LLC, you’ll file articles of organization with your state. This is called incorporating your business and at this point, you and the rest of the member-owners will be separate from your business. Many people form LLCs for liability protection, but some people also think it makes their business look more professional.
The default tax treatment for a single-member LLC is a sole proprietorship. However, you can elect to be taxed as an S Corp or C Corp.
What’s a corporation?
When you form a corporation, you’ll file articles of incorporation. Even though you might fill out some of the same forms as an LLC, it’s not the same thing.
Forming a C Corp also gives you the benefit of separating yourself from your business in liability or financial matters. Taxwise, the difference between a corporation and LLC is that you’ll be taxed as a C Corp, not a sole proprietorship—unless you elect S Corp taxation.
The difference between a C Corp and S Corp are matters for another article, but the main concerns for people involve tax filing. A C Corp gets double-taxed: first on the profits of the business, which are paid as corporate income taxes, then a second time when the dividends are paid out to the shareholders as personal income tax.
An S Corp avoids this double-taxation by paying taxes in the same manner as a sole proprietor, or as a “pass-through entity.” The business owners get taxed one time, on the earnings they get paid out from the business.
C Corp vs LLC: What you need to know
As the name suggests, one of the most notable perks of an LLC is that it limits your liability. For those who don’t want to have the business’s assets and liabilities tied to them personally, this is a major advantage. You have a legal separation between you and your company; your business is its own entity for debt, loss, profit, and damage purposes. If you apply for a loan through your LLC, in most cases your personal assets are protected if you default on the loan.
Just like an LLC, a C Corp offers its owners limited liability protection. Their personal assets are protected if the C Corp is sued or has debt in collections.
Setup and cost
Setting up an LLC requires you to file with the state, but once created, it doesn’t take much maintenance to keep your LLC status. For this reason, it’s usually cheaper to form and maintain than a C Corp.
When it comes to setup and cost, there’s a big difference between an LLC and a C corp. First, there’s the matter of the administrative work involved with a corporation. If you weren’t already paying employees as a sole proprietor, you’d probably start now. There will be ongoing paperwork, including documentation of your mandatory annual meetings.
Even if you haven’t formally sat down with your owners, shareholders, and board members before, you’ll start doing this, if for no other reason than to fulfill paperwork requirements. Small corporations need to file in the same manner as large ones to retain their corporate status.
There are also expenses when you initially file and when you hire help for your business. Most corporations at least get a tax professional to help them file their taxes each year. Many get a dedicated CPA. Choosing to become a corporation will take more time out of your year and budget; plan accordingly.
The tax benefit of an LLC is that you’ll continue being taxed as a pass-through entity (getting taxed just once on the owners’ earnings from the business); you can also elect to be taxed as a C Corp or S Corp. The point is that it’s flexible. The best taxation plan for you can usually be achieved through an LLC.
For some, the pass-through nature of an LLC is a drawback, especially if you pay an excessive amount of taxes due to the self-employment tax, which LLCs taxed as sole proprietors must pay.
C Corps also have two tax structures to choose from: C Corp or S Corp. If you want to save on taxes by reinvesting assets, you could choose the C Corp structure. But your C Corp would be double-taxed: once at the corporate tax rate, and then each owner would pay income tax if they receive dividends from the company.
If you’re wondering what is the difference between a corporation and an LLC when it comes to taxes, this is important to know. LLCs aren’t subject to double-taxation, while C Corps are.
C Corps may also choose to be taxed as an S Corp. Under S Corp taxation, the C Corp could save on taxes by only getting taxed once on salaries to owner employees—and not on dividends.
Before you choose between an LLC or corporation, consult a professional to get real-life examples of what your taxes would look like as an LLC vs. a corporation.
Because a corporation is structured to sell shares to investors, C Corps are ideal for those who want to make an initial public offering or grow their business through investments from shareholders. It’s good for those who want to grow with global investors, but you would have to pick the C Corp structure instead of the S Corp (which doesn’t allow non-U.S. resident owners).
An LLC, however, isn’t designed for companies that issue shares and want to raise money through an initial public offering. If you are interested in using stock options in the future, this is one instance you would choose a C Corp vs LLC.
Even though your LLC can’t issue shares, there’s no limit to the number of members you can have in an LLC. If you need to raise money or bring talent to the team, adding more won’t hurt your LLC status, as long as the original owners remain through the growth.
If you’re worried about an LLC’s restrictions when it comes to issuing shares and attracting investors, know that it’s possible to convert an LLC to a C Corp. The process varies by state, but it’s usually pretty straightforward.
Some industries can’t legally do business as an LLC. If you were to start up an insurance company, for example, there would be a number of legal hoops to jump through, and forming an LLC wouldn’t cut it.
Since an LLC is tied to the owners who start it, if one founder leaves, the LLC usually dissolves. You could file new articles of organization to start another LLC, but it’s not as flexible for those who won’t have the same set of owners/founders for a set period of time.
How to form an LLC vs C Corp
Each state will have its own detailed list of things to do before you’re considered an official LLC or corporation, but the main differences are:
- Forming an LLC requires owners (or “members”) to file articles of organization with their state. They will also decide on an operating agreement, which details how much equity each member owns in the business.
- Forming a C Corp requires articles of incorporation and a board of directors, written bylaws, operating agreement, and details of any stock options.
Both structures will pay fees to the state at various points in the process and may pay annually to keep the structure.
LLC vs. corporation: What’s best?
If even after reading all this, you’re still not sure about what is the difference between an LLC and a corporation, here’s a quick summary.
Most people choose an LLC when they don’t offer shares for sale and aren’t looking for global investors. It’s also the winner for tax flexibility, since you can choose to be taxed as a pass-through entity or a C Corp.
The C Corp wins when you’re a growing, global company with an interest in issuing shares. If your dream is to launch an IPO and see your company’s name on the daily stock tickers, you’ll need to get started on that C Corp paperwork now.
There are always exceptions, however, and that’s where a professional may be handy in helping you decide. No matter which one you end up choosing, the formation doesn’t have to fall to you alone. Collective can help form your LLC or S Corp and provide guidance for when your business changes.