One of the most important decisions you will make when launching your business is deciding what business structure to go with.
Generally speaking, most business owners in the U.S register their companies as sole proprietorships, with Limited Liability Companies (LLCs) and Corporations being the next favorite.
The biggest difference between a Corporation and an LLC is that a corporation is owned by its shareholders (individuals who own shares) whereas an LLC is owned by one (or more) persons.
Finding the right business entity for you will be highly dependent on your business’s industry and your personal preferences. Having said that, both LLCs and Corporations do offer a plethora of exclusive structural and monetary benefits that may allow you to excel more significantly in the long run.
Below we will explore the main differences between LLCs and Corporations, delineating the advantages and disadvantages of each one along the way.
What Is Limited Liability In Law?
Limited Liability (enjoyed by both Corporations and LLCs), is a type of protection- often referred to as a ‘corporate veil’, which distinguishes between business owners’ personal assets and those of the company in question.
This means that if a business accrues significant debt in the future that cannot be practically financed, LLC owners’ and Corporation shareholders’ assets- such as houses or cars, are completely out of bounds to any financiers.
The only exception to this, of course, is when business owners personally guarantee a loan before it is carried out, or when they are personally liable for any unforeseen damages that arise. This is undoubtedly one of the greatest advantages of both business structures, as they are both considered separate financial entities under the U.S legal system.
Having said that, LLCs and Corporations do differ quite significantly in other areas- especially in relation to taxation laws.
One of the most significant differences between Corporations and LLCs is the way in which they are taxed, and in the way, they can enjoy different fiscal benefits.
LLCs, for example, are (by default) taxed as a ‘’pass-through’’ structure- meaning that any profits generated by the business are automatically filtered (or passed through) to the owners of the LLC, which are then reported on individual persons’ tax returns, and consequently not taxed at a business level.
This means that: a) LLCs are not subject to double taxation- further discussed below, and b) filing taxes for LLCs can be (and generally is) a lot more simple than with corporations as it involves significantly less legal rigmarole.
The rate at which LLCs are taxed is solely depending on the income level of the owner(s)- similarly to a sole proprietorship. Consequently, LLCs are famous for providing many of the benefits of a corporation without being subject to the same vigorous legal requirements.
Corporations, on the other hand, are taxed as separate legal entities. This means that any profits generated by the company are initially taxed at a corporate level, and then any dividends which passed to the shareholders are taxed for a second time at a personal level (as dividends are not tax-deductible).
This concept is known as double taxation which- albeit not the most convenient, is seldom a problem for smaller businesses where owners simply pay themselves a tax-deductible salary and bonus.
Corporations additionally enjoy exclusive benefits. These include the ability to deduct all business-related expenses, such as Marketing and Advertising costs, employee salaries, and, of course, bonuses.
As of 2021, corporations are subject to a flat corporation tax rate of 21% within the U.S. This is lower than the top five income tax rates, a fact that can significantly ‘offset’ any challenges generated by the aforementioned double taxation problem. This means shareholders of corporations are able to save money on taxes by reinvesting their capital into their own company.
As touched on above, both corporations and LLCs offer a plethora of benefits. In pragmatic terms, the best option for you will highly depend on your business’s specificities and on your tailored interests as a business owner.
One thing is certain, deciding what business structure is ideal for you is one of the most crucial initial steps to starting your business.