Starting a business is filled with tough decisions, one of which is choosing the best business structure. Before selling a product or collecting a dollar, a business owner must decide what type of business he or she wants to set up. The decision will impact important things like how the company is run and how taxes are paid.
What are the options? A new business might consider setting up a sole proprietorship, a limited liability company (LLC), S-corp, or a Corporation. This guide should clearly define the differences between an LLC vs. Corporation and aid in your decision-making process.
What is an LLC?
An LLC is a type of business entity that’s registered with the state and offers limited liability protection. Personal liability protection means that an owner’s personal assets are separate from the business and aren’t used to rescue the business if it ends up in financial troubles or is sued. Only business investments can be used to satisfy the liability.
The owner of an LLC pays taxes on the profits earned from the business, but those taxes are passed through to the owner’s personal tax returns. The business itself cannot earn income, just the owner. The rate at which the owner is taxed depends on the total income of the owner.
An LLC has a lot of flexibility in its ownership and management. One or more members can own or operate the company.
What is a corporation?
A corporation, sometimes called a c corp, is a legal entity that’s registered with the state and offers limited liability protection, just like an LLC. So, the corporation must file documents with the state to officially do business and the owner has limited liability protection that protects personal assets.
However, the main differences between an LLC and a corporation are in ownership, management structure, and tax status.
A corporation is owned by shareholders, who can buy, sell, or transfer shares of stock. It must have a formal structure run by a board of directors. Rules that govern the company, known as bylaws, are created and adopted by the corporation once it’s formed. In addition, an annual shareholders meeting is required every year, where minutes must be kept.
Taxes are vastly different for a corporation too. Corporations are subject to double taxation. Essentially, the corporation is taxed, and then shareholders are taxed on their dividends.
Benefits of an LLC
Ownership and management flexibility
An LLC has a lot of flexibility in the way it’s owned and managed. Small businesses can name as many owners (known as members) as they’d like and can assign management positions to whomever they see fit. That’s not the case for a corporation that’s ruled by a strict corporate structure, which includes a board of directors that’s in charge.
An LLC doesn’t have to hold annual meetings, take minutes, or keep nearly as many records as a corporation. For small businesses or companies with minimal resources, this is ideal.
No double taxation
An LLC doesn’t pay taxes twice. Income earned by the owner is taxed based on personal income and paid via a personal tax return. A corporation is a different entity type that earns corporate profits, which are taxed, and then taxed again once they’re given to shareholders.
Benefits of a corporation
Access to capital
Most corporations can raise money quickly by selling stock, which is a luxury not held by an LLC. It gives corporations a chance to access money for growth or for financial troubles.
Since ownership is determined by the amount of stock one owns, it can be transferred for generations to keep the company alive.
How to form an LLC
Before electing to set up an LLC, here’s what it takes to form one:
1. Choose a business name
The owner must select a business name. While that sounds simple, there are a few state rules entrepreneurs should be aware of. For starters, no two businesses can have the same name. All business names must be distinguishable from one another. As a result, the owner must conduct a business name search to see if the name is available. Usually, this search can be conducted on the secretary of state website. If the name is already in use, a different name must be selected.
2. Pick a registered agent
Every business needs a registered agent. A registered agent is a person or company that accepts important documents on behalf of your business. These documents might include tax notices or service of process papers that are served during a lawsuit.
Who can be a registered agent? Most states allow the business owner to serve as the company’s registered agent. An employee, friend, or another adult can also be selected, as long as that person has a physical address. A registered agent service can be hired to fill the role as well.
3. File Articles of Organization
With a name picked out and a registered agent in mind, a business owner can fill out LLC formation documents, which are usually called Articles of Organization. (Some states call them Certificate of Formation or Articles of Formation).
This form asks for the company name and address, the registered agent’s name and address, a list of managing members, the company start date, and a brief description of the company’s purpose. This document, which can usually be found and filed online through the secretary of state’s office, also comes with a filing fee. The average filing fee is $132, but states range anywhere from $50 in Arizona to $500 in Massachusetts.
These simple steps create an LLC. Before working with customers though, it’s also a good idea to do the following:
- Create an operating agreement
- Obtain an employer identification number (EIN) from the IRS
- Look into any business licenses or permits that are required to operate
How to form a corporation
Forming a corporation is similar to forming an LLC, but there are a few differences. Here’s how to set up a corporation:
1. Pick a business name
The corporation needs a name and it must be available to use. States won’t allow two businesses to have the same name, so check the secretary of state website for a business name search tool. Run a search, check availability, and let the information found guide the selection process.
2. Select a registered agent
Both LLCs and corporations need to select a registered agent to accept important documents. These documents could be tax notices or legal documents, so select a trusted person for this position. It can be the corporation owner, an employee, or registered agent service.
3. File Articles of Incorporation
To establish a corporation in any state, one must file Articles of Incorporation. These documents are similar to Articles of Organization that are filed to register an LLC. It asks for the company name and address, the registered agent’s name and address, a list of directors, the date the company started, and a brief description of the company’s purpose. This document is electronically signed and submitted to the state, usually to the secretary of state’s office.
A corporation is officially launched with the approval of Articles of Incorporation, but a corporation should also do the following before collecting its first dollar:
- Create a shareholder’s agreement
- Write corporate bylaws
- Hold a board of directors meeting
- Obtain state and local business permits and licenses
- Open business bank accounts
To further your understanding of LLCs and corporations, here are answers to frequently asked questions:
Do both corporations and LLCs have to file annual reports?
Yes. In most states, both LLCs and corporations must file an annual report and pay a filing fee. Research annual report filings through the secretary of state website.
What’s the tax rate for corporations?
The U.S. imposes a 21% corporate income tax on all corporations.
How are LLCs taxed?
LLCs aren’t taxed twice as corporations are. The owner’s profits are passed to his or her personal tax returns and taxed based on income.
How long is an LLC active?
When an LLC is registered with the state, it’s good for one year. After that, the LLC must file an annual report and pay a filing fee. This continued compliance effort keeps a company active and in good standing with the state.
Is the owner of an LLC given a salary?
Usually, an LLC owner isn’t given a salary. Instead, the owner draws profits out of the business as needed. These transactions are known as an owner’s draw.
How are board members of a corporation compensated?
Board members are compensated through a variety of methods including cash, stock awards, and retainer fees.
What’s a C corporation or an S corporation?
A c corp and an s corp are both corporations, but with different tax purposes. A c corp is usually subject to double taxation while an s corp reports business income on personal tax returns.