LLC vs. Corporation: What Entity Is The Right For You

Choosing the right entity

You finally decided to form your own legal entity. However, how would you know which one is the best choice for you particular needs?

To make this choice wisely it is important to understand the basic differences between various types of legal entities. This article focuses on comparison between LLC (limited liability company), one of the most popular business entities today, and various forms of corporation, namely C- and S-Corporation.

C-Corporation vs. S-Corporation

All corporations start as C-Corporations and are required to pay income tax on taxable income generated by the corporation. An C-Corporation becomes a S-Corporation by completing and filing federal form 2553 with the IRS.

1. Taxation:

An S-Corporation's net income or loss is "passed-through" to the shareholders and are included in their personal tax returns. Because income is NOT taxed at the corporate level, there is no double taxation as with C corporations.

2. Difference in income allocation:

Subchapter S-Corporations, as they are also called, are restricted to having no more than 100 shareholders, and cannot be owned by C-Corporations, other S-Corporations, many trusts, LLCs, partnerships, or non-resident aliens.

LLC vs. C-Corporation

There are three principle differences between LLC and C-Corporation:

1. The entities are taxed differently:

An LLC is a pass-through tax entity, meaning that the income is not taxed at the company level (however, LLC is still required to complete a tax return). The income or loss as shown on this return is "passed through" the business entity to the individual shareholders or interest holders, and is reported on their individual tax returns.

C-Corporation is a separately taxable entity, and pays tax on the income prior to any dividend distributions to shareholders. If and when corporate earnings are distributed to shareholders in the form of dividends, the corporation does not receive the reasonable business expense deduction, and dividend income is taxed as regular income to the shareholders.

3. The entities differ in their structure:

LLCs are less rigid in their structure than corporations, so you have more flexibility in adapting the LLC to your unique business. The Operating Agreement of an LLC can be structured in a limitless amount of ways.

4. Formality:

A corporation is a formal entity with officers and directors (at least one of each) required. An LLC, on the other hand, can be "member managed" and run in a less formal way. For small, start-up businesses, less formality means you can focus on making money rather than administrative work.

LLC vs. S-Corporation

Even though LLC and S-Corporation have a lot in common, those two types of entities differ on the following:

1. Difference in income allocation:

While S-Ccorporation special tax status eliminates double taxation, it lacks the flexibility of an LLC in allocating income to the owners. An LLC may offer several classes of membership interests, while an S-Corporation may only have one class of stock.

2. Ownership restrictions:

Any number of individuals or entities may own interests in an LLC. However, ownership interest in an S-Corporation is limited to no more than 100 shareholders, and S-Corporations cannot be owned by C-Corporations, other S-Corporations, many trusts, LLCs, partnerships, or non-resident aliens. Also, LLCs are allowed to have subsidiaries without restriction.

Those are just the principle differences between the three most popular entities. However, when choosing to organize a business one should consider other less popular types of legal entities, as those might answer to particular needs of the business. Consider discussing your situation with a licensed attorney or a CPA, familiar with your situation and whatever requirements your state might have for forming various business entities.