LLC or Corporation - Which Should I Select for My Business?

LLC and Corporation - What's the Difference?
LLC and Corporation - A Comparison. Thomas Barwick/Getty Images

Everyone loves to give advice to new business owners. One common piece of advice goes like this: "Don't form an LLC. Form a corporation." Or, "Corporations are too complex. Just form an LLC." Confused? Let's sort out the differences between an LLC and a corporation so you can decide which business type is best for your business. 

LLC or Corporation - What's the Difference?

Business organizations (not including sole proprietors) must register as a specific business type with the state in which they do business.

All states recognize businesses formed as corporations, limited liability companies (LLCs) or partnerships, or variations of these forms. For a new business, it's often difficult to know which type of business is the best, considering all factors. This article gives you some information on differences and similarities between LLC and corporation business forms, the two most popular business types.

Why is an LLC NOT a Corporation?

There's no such thing as a "limited liability corporation." An LLC is a limited liability company,. It's not a corporation, and you don't incorporate a business as an LLC. Both register with a state, but an LLC doesn't "incorporate." 

First, let's look at the two common types of businesses, for tax purposes:

  • "Pass-through" Businesses
    Pass-through businesses are those in which the profits and losses of the business pass through to the owners or shareholders. In other words, the business income is considered as the owner's or shareholder's income, and the owner/shareholder pays the tax on his or her personal tax return. Limited liability companies, like partnerships, are pass-through entities.
  • Separate Business Entities
    Corporations are separate businesses entities. The profits and losses of the corporation are taxable to the corporation, not the owners (shareholders).

How are LLCs and Corporations Formed?

  • Starting a Corporation
    A Corporation is a separate legal entity. It is formed by filing corporate organization forms in the state where the corporation is located, and by designating shareholders, each with a specific number of shares. The corporation also creates a Board of Directors to oversee the corporate business.

How are Corporations and Limited Liability Companies Alike?

Both corporations and LLCs limit the liability of the owners/shareholders from the debts of the business and against lawsuits against the business.

Corporations vs. LLC's - Tax Differences 

Corporations and LLCs are different in how they are taxed. Because corporations are separate entities, they are taxed at the corporate rate, while LLCs are taxed based on Adjusted Gross Income of the owners. Here is an example:

  • A corporation has a profit of $350,000 for 2007. That profit is taxed at the corporate tax rate of 35 percent. 
  • An LLC has the same amount of profit of $350,000. Its two Members each have a 50 percent share in the LLC, so each one is taxed on $175,000 of income on his or her personal tax return. The income from the LLC is included in the 1040 on line 12, and is considered along with other income for that person or couple for that year.

    An LLC may choose to be taxed as corporations, if this is advantageous to the company.

    Corporate and LLC Owners and Taxes

    The tax consequences to LLC and corporate owners are different. Owners of a corporation are not paid, but they receive dividends; they are taxed on their dividend income. Owners of an LLC are taxed like partners in a partnership; that is, they receive a distributive share of the profits each year, and pay taxes on that share on their personal tax returns.

    Owners of an LLC also pay self-employment tax on their income from the business, while corporate owners who work in the business are considered employees and pay tax on their employment income, along with FICA taxes. 

    How you are paid - and taxed - as an owner of an LLC or a corporation could be a major factor in determining which form of business you choose.


    A Third Possibility - An LLC Taxed as a Corporation

    Just to muddy the waters, you might want to consider forming an LLC and then electing to have the LLC taxed as a corporation or S corporation. While this is more complicated, it combines the advantages of the LLC with the tax benefits of a corporation. 

    Who Can Help Me Make This Decision? 

    Still confused about whether to start an LLC or a corporation? It's a complex decision and one you shouldn't make quickly. As noted above, the tax consequences can be a deciding factor. Before you make a decision, talk to two people: 

    1. An attorney who has experience with both LLC's and corporations. A good attorney will consider LLC's in addition to traditional corporations. 

    2. A CPA who understands the tax differences between LLC's and corporations. 

    This article about 7 questions to ask before deciding on a business type might also be helpful. 

    For more information, check out this complete outline to my Guide to Business Types

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