Owning a business means becoming an expert in compliance. Tax regulations, filing deadlines, and other legal issues rule how and when you can do business.
But not all businesses have the same amount of paperwork to keep up with. There are several different types of business entities that all come with their own set of rules.
Two of the most common business entities are corporations and LLCs. Take a look at this overview of when you should choose a corporation vs LLC.
What is a Limited Liability Company?
A Limited Liability Company is a state-recognized entity. It's an entity many people choose instead of a sole proprietorship to help protect their personal assets.
Some states require special LLCs if you work in a certain industry. Choose an LLC if you want a relatively cheap option to launch your business.
LLCs are easy to open requiring less paperwork than other entity types. Anyone currently operating a sole proprietorship should consider upgrading to enjoy the legal protections of an LLC.
How Does an LLC Work?
An LLC protects the owner's personal assets in case the business is sued. Personal assets include things like your personal income, savings, and house.
If your business can't repay its debts, you aren't responsible for repaying them out of your personal income in most cases. These protections vary by state since an LLC is a state-regulated entity.
But typically, when debtors come to collect any money owed they'll tap into your business bank account and assets to collect. Another perk of choosing an LLC is the option for pass-through taxation.
Pass-through taxation is a major benefit for LLC owners because it allows you to deduct business expenses on personal tax returns. This means spending less money on tax preparation fees since you won't need to file a separate return for the business.
You also pay less in income taxes altogether. Your personal income is offset by the deductions you claim on Schedule C. Schedule C lists all your business expenses and income for the tax year.
Want to start a business with a dozen other partners? How about a hundred?
With an LLC, there's no limit to the number of owners you can have. Start with just one owner in a single-member LLC or add members as you go.
There's little paperwork needed to make changes to an LLC making it one of the most flexible business entities to operate. LLCs are managed by its members.
Not every member has to be a Managing Member. Some can be simply passive owners that aren't responsible for the day to day business operations.
Pass-through taxation is one of the best-known perks of operating an LLC. But you can also select how you want to file your taxes as an LLC owner.
Most new business owners don't realize they can switch from pass-through taxation to elect a corporation filing status. Why would a company want to do this?
Pass-through taxation is helpful in the first few years of your business when you have lots of expenses and little income. It helps to keep your tax burden manageable until you start to make a substantial profit.
Once your business income gets above a certain threshold, you don't want it counted on your personal return. In this case, you can start to distance yourself from your business income by electing to file as a corporation.
What is a Corporation?
There are two ways to formally incorporate your business. The first way is through an S corporation and the second method is a C corporation.
With both types, owners receive a certain percentage of the business called shares. Corporate shares can be transferred between owners or shareholders.
This makes a corporation one of the top options if you're looking to attract outside investors. There are two ways corporations pay taxes.
The first method is taxation as a C corporation. The business pays federal income taxes on any corporate profits. Individual owners also pay taxes if they receive dividends from the business.
A dividend is a payment the owner receives when the business profits. Owners pay taxes on dividends on their business tax return and on a personal tax return.
This is often referred to as double taxation. If a corporation has less than 100 shareholders it can elect to file as an S corporation.
The benefit of filing as an S corporation is being able to skip corporate income tax. The downside though is that all profits from the corporation pass through to the shareholders' personal tax returns.