The Bankrate promise
At Bankrate we strive to help you make smarter financial decisions. While we adhere to strict , this post may contain references to products from our partners. Here's an explanation for .
While you can run a business as a sole proprietorship, there may come a time when you want to create a more formal legal structure for your company. Two options that you can choose from are LLCs and corporations.
Each has pros and cons that you need to consider before deciding on how to organize your business.
What is an LLC?
A limited liability company (LLC) is a business entity that helps to protect the business owner from the liabilities incurred by the company they own.
As a sole proprietor, you and your business are one and the same. Your business’s debts are your debts and you have to pay them if your company can’t. If someone sues your company, they’re suing you.
With an LLC, your personal assets are shielded and kept separate from your company’s. But they still offer relatively simple tax filings, with all of the company’s profits or losses passed through to your personal income tax return.
While LLCs offer protection of your personal assets, it’s possible to lose that protection. If you don’t properly keep personal and company money separate, for example, you can lose LLC protection.
Another way to lose that protection is by signing a personal guarantee. If an LLC loan requires a personal guarantee, you promise to pay for the loan out of your own money if the business can’t. That means you’re forgoing that protection.
The owners of an LLC are called members. LLCs can be single-member entities or multiple-member entities. In many states, members can be individuals, corporations, foreign entities or even other LLCs.
What is a corporation?
A corporation is a distinct legal entity that is separate from its owners. Like LLCs, corporations offer a variety of liability protections. But they can be far more complex and come in multiple forms.
C corporations are typically large, legally complex entities that offer strong liability protections to their owners. Owners of C corporations own shares in the company, with those shares giving owners control over the business.
C corporations have significant bookkeeping and accounting requirements and must file taxes separately from their owners. That means that the owners of a C corporation may deal with double taxation as the corporation pays taxes and they pay individual taxes.
With a C corporation, shareholders can sell shares and the company can continue operating. With an LLC, one member leaving can require a complete business restructuring.
An S corporation is a special form of corporation designed for smaller companies. They can only have a maximum of 100 shareholders.
Like other corporations, S corps have detailed accounting and bookkeeping requirements. However, S corps can pass much of their profit and losses to their owner’s personal taxes. That vastly simplifies tax filing and helps S corporations avoid corporate taxes.
In some cases, LLCs can elect to be taxed as S corporations, which can offer tax benefits.
B corporations, also called benefit corporations, are for-profit entities that aim to work for the public good. They pay taxes and deal with bookkeeping like other corporations but may have to submit regular reports regarding how they’ve used their money to achieve their mission of benefiting some public cause.
Ownership in a corporation is conferred through shares. Shareholders exert control over the business based on the number of shares they own. They can also sell shares to other people. Even as shareholders change, the corporation can operate without being significantly impacted.
LLC vs. corporation
LLCs and corporations are both legal entities that business owners can use to formalize their company’s legal status. Corporations are generally more complex and better suited to larger entities, while LLCs are simpler.
Generally, forming an LLC is cheaper and easier than forming a corporation. To start an LLC, you’ll choose a name and registered agent (you can usually be your own agent), fill out your state’s article of organization and submit them. Then all you need to do is meet the annual filing and reporting requirements.
Filing costs vary from about $50 to a few hundred dollars.
Forming a corporation is typically more expensive and takes more work. You need to appoint directors, file articles of incorporation, write corporate bylaws, draft a shareholder agreement, hold initial meetings and issue stock and register your company with the state and IRS.
Filing requirements can be complex, so you may need a lawyer.
Like sole proprietors, LLCs are largely pass-through entities, so they don’t have to worry about corporate taxes. Instead, all income passes to the owner, who then pays taxes on the profits.
- John Smith Ventures LLC has one member, John Smith. It produces $60,000 in profit for the year.
- John Smith receives $60,000 from the LLC. He reports that income on his personal tax return on Schedule C.
- The LLC does not file a tax return.
Corporations, on the other hand, are separate entities that must file taxes. The corporation’s owners also file taxes, meaning corporations have far more complex tax filing procedures. They may also be subject to double taxation.
- Jane Smith Ventures Inc. has one shareholder, Jane Smith. It produces $60,000 in profit for the year.
- Jane Smith Ventures Inc. files its tax return and pays 21% in corporate taxes, sending $12,600 to the IRS.
- Jane Smith Ventures Inc. pays $30,000 in dividends to its shareholder.
- Jane Smith files her tax return, reporting $30,000 in dividend income and paying income taxes.
How to choose the right business entity
Choosing the right business entity is essential because it can greatly affect how your company operates and manages its finances.
In general, LLCs are far more flexible in dealing with the IRS. If you’re working alone or have one or two partners, an LLC might be the better choice given their flexibility and simpler filing requirements.
Corporations are generally best for larger, more complex entities. If you ever plan to go public, raise money selling shares or want the freedom to keep operating without major impacts should one owner choose to sell out of the business, a corporation is the way to go.
Keep in mind that you may be able to change your business structure as time passes. Check with a local attorney to learn more about your options.
LLCs and corporations both offer liability protections to their owners but they function quite differently when it comes to filing requirements and taxes. Consider the pros and cons of each before deciding which one to form.
Frequently asked questions
LLCs and C corps both have benefits, but LLCs beat C corps in terms of simplicity, being easier to form and being less expensive to form.
LLCs protect their owners from liability, but you could lose those protections if you fail to keep business and personal money separate or sign a personal guarantee on an LLC loan.
If you run an LLC, you often have to pay self-employment taxes on the money you earn, which can mean paying more taxes. Their profits also immediately pass through to your tax return, making it harder to manage your income for tax efficiency.