So you’ve decided the time’s come to formally protect yourself from liability in your business. Or perhaps your current business has grown, and you need to update the structure to suit current requirements. In any case, it’s good that you’re at least taking the time to understand what options are available to you.

Limited Liability Company (LLC) and corporations are both great options. Which one you register for will ultimately depend on your business needs and long-term goals.

The first thing to know is that the business structure you go for will pretty much define how the business is run from then on — how you raise money, how much you pay in taxes, the type of paperwork you’ll file, and so on.

This type of decision requires careful thought. While it is possible to convert to a different business structure in the future, you may encounter certain restrictions, which could impact many areas of your business, including possible tax consequences.

Let’s break each option down so you can make an informed decision.

LLC Overview

A limited liability company is a business structure that protects the personal assets of its members. The members here are the business owners.

If the business entity is in debt and sued by the creditor, or it gets enmeshed in a legal quagmire, the LLC members get to enjoy personal liability protection. In other words, the plaintiff can only go after the assets of the business and not the personal asset of the business owners.

This type of business structure is generally common among startups, sole proprietors, small business owners, and real estate investors because of this immense benefit. Sole proprietorship and partnership entities tend to favor LLCs when the time comes to scale the business. It’s straightforward and generally doesn’t have as many requirements as a corporation.

How are LLCs run?

An LLC is governed by an LLC Operating Agreement. Think of it as a contract with a manual for how the owners should run the business. This operating agreement is important because it helps to avoid disputes with ownership and other potential complications down the line.

Unless you’re registering a single-member LLC, the biggest risk is usually the business partners. That’s why this contract needs to be in place to protect the membership interests.

How are LLCs taxed?

Another great feature of an LLC is that the members enjoy certain flexibility with how the business entity is taxed. The default is to report taxes through a method known as pass-through entity taxation.

This means the taxation will ‘pass through the entity and will instead be reported in the personal income tax of the respective members. It’s like a self-employment tax as opposed to filing a corporate tax return.

LLCs also have the flexibility to be taxed as a different entity type, such as an S corporation (S-corp). In this setup, the business owners must receive a reasonable salary from the business, which is then reported as a business expense from which payroll taxes are deducted. Any profits after taxes are then distributed as dividends.

Who can register an LLC?

Any company of any size can register as a limited liability company. Professional service providers, such as dentists, ophthalmologists, plumbers, electricians, and so on, could greatly benefit from setting up an LLC business structure.

Real estate investors looking to own commercial property can also set up an LLC as a legal entity for their investments.

Corporation Overview

A corporation has more stringent rules and has multiple levels of bureaucracy. They also typically require more extensive recordkeeping and reporting. However, in return, corporations provide the highest level of personal liability protection to their owners. These owners are the shareholders.

The assets of a corporation are completely separated from the personal holdings of its shareholders. If a shareholder offloads their shares or decides to leave the company, the corporation can continue normal operations relatively undisturbed.

One of the biggest advantages that corporations offer is that they can raise money by selling their stocks. This makes them ideal for medium- or higher-risk businesses with sizable corporate income.

How are corporations run?

In a corporation setup, the business entity is governed by its articles of incorporation. Incorporating your business means securing your articles of incorporation with the state. Each state has its distinct paperwork requirements and guidelines for filing these formation documents. The secretary of state oversees all incorporation filings.

In addition to the standard requirements of incorporation, some states may request the business to provide a copy of the company bylaws. These bylaws outline the responsibilities and rights of the corporation’s shareholders and board of directors.

The state officials will review the application for articles of incorporation. If cleared and all appropriate fees have been settled, the company will be notified of its corporation status shortly after.

How are corporations taxed?

Unlike other types of business structures, corporations are required to pay income tax on their profits. In some cases, these corporate profits are subject to double taxation — once when the company records a profit at the end of the financial year and another on the shareholders’ personal tax returns when they receive their dividends.

Types of corporations

C corporation (C corp)

This is one of the most popular types of corporations, especially for tax purposes. In a C corporation, the company’s profits are taxed outside of the business owners’ profits.

There’s also no stringent rule regarding the background of shareholders or the number. This means even their own employees can be shareholders in the company. However, the organization must board of directors who are responsible for its management.

C corps may have to deal with double taxation. To avoid it, the company can spread its profits to its employees in the form of benefits. This allows the organization to be subjected to a lower tax rate.

S corporation

An S corp is designed to avoid incidences of double taxation and its resulting impact on the company’s profits. In this setup, some profits and losses are passed directly to the personal income of the owners. These amounts are not subject to corporate tax rates.

Specific guidelines on the registration and tax payments of S corps tend to vary by state. Some states, including the District of Columbia, Texas, Tennessee, and Louisiana, don’t recognize the S corp election and instead treat the business as a C corp. In any case, getting S corp status means filing with the IRS in line with its regulations. The process differs from state to state.

S corps are subject to certain limitations. For instance, the company cannot have more than 100 shareholders, all of whom must be U.S. citizens.

B corporation (B corp)

Also called a benefit corporation, this type of business entity differs from C corps in purpose, accountability, and reporting. However, they are taxed pretty much the same way. This type of corporation is driven by both profit and a mission dedicated towards public benefit.

In some states, B corps are required to submit an annual report detailing the company’s contributions towards the public good.

Close corporation

These are similar to B corps but with a less traditional corporate management structure. Of course, state rules apply too, but those tend to vary. In any case, shares in a close corporation are not open to public trading.

In some instances, these close corporations don’t need a board of directors. Instead, it can be run by a small group of its shareholders.

Nonprofit corporation

Nonprofits are set up with the primary aim of providing purely beneficial services to the public. This can be through charity work, education, science, or religious programs. Because they are 100% dedicated to working to benefit the public, nonprofit corporations are exempt from paying income taxes (both state and federal) on any profits that they accrue.

Nonprofits are required to file with the IRS (501(c)(3) corporation) to be awarded the tax-exempt status. This is different from the usual registration process with the state. Additionally, these organizations must abide by certain rules, especially regarding business income and profit-sharing. For instance, they’re not allowed to distribute their profits to members or expend it on political campaigns.

Are there any similarities between LLCs and corporations?

An LLC and a corporation share certain similarities, especially when compared to other types of business structures like partnerships and sole proprietorships. These include:

• Formation — Both are regarded as business entities that require filing necessary documents with the state. For the setup process, LLCs file articles of organization while corporations secure articles of incorporation with the secretary of state’s office.
• Limited liability — Owners of LLCs and corporations enjoy limited liability. This means the owners/members’ personal assets are not up for grabs should the company face bankruptcy or a crippling lawsuit.
• Registered agent requirements — LLCs and corporations must have a registered agent in every state where they conduct business. A registered agent is a designated entity that is assigned to receive legal notifications on behalf of the corporation.
• State compliance — Both LLCs and corporations are required to comply with the state’s regulations. This usually includes filing annual reports and paying the relevant fees.

Which one should you go for?

Let’s look at scenarios where either would make sense over the other.

When registering an LLC may make sense

If you’re a small business owner looking to separate yourself from your business, the relative flexibility and simplicity of an LLC make it the ideal choice. Even more so, if the business owns assets that are likely to rise in value over the years, such as real estate. With an LLC, business owners can also avoid double taxation.

When registering a corporation may make sense

There are a number of factors that might make registering a corporation the smart choice. These include:

• You want to raise money from the public — When you expect to raise funding from multiple investors and shareholders, a corporation is the way to go. LLCs don’t have any class of stock that they can sell so they must raise money through other ventures.
• You want to reap extensive fringe benefits — With a corporation, you can be both shareholder (owner) and employee (CEO). This can entitle you to a tax-deductible salary along with a number of fringe benefits, such as paying for your health insurance premiums, receiving reimbursements on medical expenses, and so on.
• You want to keep key staff by offering them stock options — Quality employees are as scarce as they come these days. Some are so valuable that it would take more than the usual remuneration and benefits package to keep them in the company. Incorporating your business allows you to offer them the chance to be shareholders who are therefore financially invested in the success of the business.

In any case, consulting with a business law firm can prove valuable as it can help you navigate the nuances of the filing and registration processes.

The bottom line

Once you understand your options and their resulting implications, it becomes much simpler to select the right business entity. Remember, your needs will likely change over time. Take your time, do your research and consider both your short and long-term goals for your business.

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