When a small business owner decides they want to incorporate, they often struggle to decide what type of incorporation to choose. While it can all be pretty overwhelming in the beginning, we hope to lay out the advantages and disadvantages of starting an LLC or a corporation, whether or not to classify it as an S Corp or C Corp, and give you a better idea of which one would be best for your business.
If you need a refresher on what incorporating means for your business, here is a brief explanation:
"Incorporating a business is defined as the legal separation of a business entity from its owner. This new business 'person' is completely independent, meaning that even if something happens or changes take place with owners or administrators, the business will keep running and functioning as normal and without having to also change."
Both an LLC (Limited Liability Company) and corporation provide protection for you and your business. In either case, you are no longer personally responsible for your business' liabilities and cannot be personally sued for your business' actions. If you invest a certain amount into your business, you can only be held financially responsible for that amount of money and no more. There are, however, some big differences when it comes to business structure and taxation.
There is no requirement for an LLC to have a certain business structure. The owners of the business are designated as "members," but they are allowed to set up the business however they choice. This is one of several benefits of an LLC.
In contrast, a corporation is required to have a set structure:
If a business is small enough, the owner may act as all three and be the sole shareholder, director, and officer of his or her corporation.
While the business structures are similar in some ways, the way each one is taxed is vastly different. Firstly, when it comes to taxation, a corporation can decide whether it wants to be an S corporation (S corp) or a C corporation (C corp); however, an LLC can also choose to be taxed as an S corp, C corp, or as an LLC. What are the differences and advantages to each one? Let's take a look.
When a business is taxed as an LLC, the owner reports business income and losses on his or her individual tax return. For this reason, LLCs are called "pass-through entities." The business itself is not taxed on its profit, but rather it passes through to the owner. The advantage to this is that it makes taxes a lot easier to report. The disadvantage is that the owner has to pay the self-employment tax, which requires sending in quarterly estimated tax payments. Another disadvantage is that it's harder to separate the owner from the business.
S corps are similar to LLCs in that they are also considered pass-through entities. The owner can often claim losses from his or her business as deductions on his or her individual tax return, but does not have to pay self-employment tax. The downside to S corps are found more in their business structure—they are limited to no more than 100 shareholders (who must be American citizens), and they cannot be owned by another LLC, S corp, or C corp. For this reason, many business owners decide to structure their business as an LLC, but file taxes as an S corp.
C corps, in contrast, are taxed as a separate entity from the owners. This separation means that there is a little more protection for the owner because he or she is only required to pay taxes on their share of the profit. However, it often means the business owner is taxed twice—once on the corporate level and then again on his or her individual tax return—which can prove to be costly for a small business owner. Also, C corp business owners cannot claim business losses on their individual tax return.
All three different options have their advantages and disadvantages both with taxation and structure, so the decision should come down to what would work best for your particular business as you look at the future. If you would like to talk more about your options and ask questions, please contact us and set up an appointment with one of our registered agents.
In the meantime, check out this basic comparison chart of common business entities.
At MaxFilings, you can incorporate your business right away… or just start organizing all your information here until you’re ready!