Business structures | Chamber of Commerce https://www.chamberofcommerce.org Sun, 14 May 2023 15:39:41 +0000 en-US hourly 1 https://wordpress.org/?v=6.1.1 https://www.chamberofcommerce.org/wp-content/uploads/2023/06/cropped-display-photo-1-32x32.jpg Business structures | Chamber of Commerce https://www.chamberofcommerce.org 32 32 Sole Proprietorship vs Corporation: What’s the difference? https://www.chamberofcommerce.org/sole-proprietorship-vs-corporation Tue, 31 Jan 2023 10:39:40 +0000 https://www.chamberofcommerce.org/?p=29694 Choosing the most suitable business structure for your business is one of the most important decisions you’ll make as an entrepreneur. Irrespective of whether you’re starting a large or new small business, the entity type you select should reflect your company’s goals for you to have the best possible benefits and results. Two of the […]

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Choosing the most suitable business structure for your business is one of the most important decisions you’ll make as an entrepreneur. Irrespective of whether you’re starting a large or new small business, the entity type you select should reflect your company’s goals for you to have the best possible benefits and results. Two of the most common business structures are sole proprietorships and corporations. However, each entity type has its own advantages and drawbacks. The following guide will outline the differences and similarities between sole proprietorships and corporations and help you make an informed decision.

What is a sole proprietorship?

Sole proprietorships are unincorporated businesses having only one owner. However, if more than one owner is involved, it is automatically considered a general partnership. A sole proprietorship’s profits or income is taxed as the owner’s personal income.

They are also one of the easiest entity types to set up and maintain, making them one of the most common business structures. However, it’s not considered a separate legal entity by the IRS like other structures such as limited liability companies and corporations.

When starting a sole proprietorship, there are no forms to file or fees to pay. You only need to consider if you’re going to be using your own name as your business name. If not, you’ll need to register a DBA or “doing business as” name per your state laws and regulations.

Sole proprietorship benefits

  • Easy formation: One of the most obvious advantages of creating a sole proprietorship is the simple establishment of the entity. Aside from that is also quite inexpensive and less time-consuming than creating a corporation.
  • No restrictions on the number of employees: Sole proprietorships don’t limit the number of employees you can have, allowing you to grow and get closer to incorporating your business.
  • Business name protection: When running a sole proprietorship, your business’s legal name is, in fact, your name. If you’d like to change this or operate under a different name, you can register a trademark through the USPTO or file a DBA with your state or county clerk’s office.
  • Complete control: As a sole proprietor or owner of your business, you have complete control of the day-to-day operations, decision-making process, etc.

Sole proprietorship drawbacks

  • Unlimited legal liability: Since there’s no separation between the sole proprietor and the business, the sole proprietor is liable for all debts and obligations, malpractice claims, lawsuits, etc., brought against the business.
  • Skills and experience: It can be quite challenging for sole proprietors to manage all aspects of the business alone. A sole proprietor must have the necessary skills and experience to make sound decisions that ultimately cause the business to succeed or fail.
  • Backup and succession: If the owner does not want to run the business, it ends. Additionally, since sole proprietorships do not have separate legal identities, the business cannot pass any tangible assets from one owner to another.
  • Limited access to credit: Other types of business structures like corporations, limited liability companies, and partnerships have more history and income when applying for credit than sole proprietorships, so it becomes increasingly challenging for sole proprietors to secure financing as they are seen as individuals and not businesses.

What is a corporation?

Corporations are considered legal entities that are distinct from their owners or shareholders. Therefore, corporations have limited liability protection, so owners’ personal assets are protected if the corporation is sued or has debts and business expenses to be paid.

However, you should be aware that corporations are subject to double taxation, which means that the profits of a corporation are taxed twice, first on the corporate level and then again on the personal tax returns of the owners or shareholders.

Therefore, corporations are subject to corporate and personal income tax on the shareholder’s tax returns.

Additionally, compared to sole proprietorships, corporations have many more corporate formalities involved, such as filing the Articles of Organization or Articles of Incorporation, nominating a registered agent, holding annual shareholder meetings, and keeping all important legal documents in a safe place.

Corporation benefits

  • Personal asset protection: One of the benefits of incorporating your business is enjoying limited liability protection. Limited liability or personal liability means that your personal assets cannot be used to pay off business debts.
  • Quicker funds and easy transfer: Corporation ownership can be transferred. Capital can be raised through a stock sale, and banks and financial institutions have faith in lending money to incorporated businesses.
  • Tax benefits: Corporations can gain tax benefits by writing off certain expenses, such as savings on self-employment taxes, health insurance premiums, and life insurance.
  • Privacy: If you value your privacy and don’t want your involvement with a small business to be public knowledge, then the best way to do this is to incorporate your business.

Corporation drawbacks

  • Double taxation: The default corporation structure is the C corporation, which is liable for double taxation. Double taxation means the corporation is taxed at the corporate level, while individuals or shareholders are again taxed on their share of the dividends.
  • Stringent formation and compliance requirements: The formation of corporations includes initial and annual record-keeping requirements compared to other types of entities like partnerships and sole proprietorships.
  • Initial and ongoing fees: Incorporating a business is not a cheap affair. This is because you need to pay fees when forming and operating the business to keep it in good standing.

At a glance: How is a sole proprietorship different from a corporation?

  • Corporations are considered legal entities that are distinct from their owners or shareholders. Therefore, corporations have personal liability protection, so owners’ personal assets are protected if the corporation is sued or has debts and business expenses to be paid.
  • However, you should be aware that corporations are subject to double taxation, which means that the profits of a corporation are taxed twice, which is first on the corporate level and then again on the individual tax returns of the owners or shareholders.
  • Additionally, compared to sole proprietorships, corporations have many more corporate formalities involved, such as filing the Articles of Organization or Articles of Incorporation, nominating a registered agent, holding annual shareholder meetings, and keeping all important legal documents in a safe place.

Should I start a sole proprietorship or corporation?

Deciding whether to form a sole proprietorship or corporation involves careful consideration. If you are trying out a new business idea and you’re not entirely sure if you will continue with it in the long run, a sole proprietorship could be a better option.

This is because you can run your business under a different name or DBA and enjoy a favorable tax advantage without investing too much money in forming the business.

However, if you plan on having more than one owner involved in your business, you anticipate that the business will grow at a speedy rate and will be in it over the long run. Therefore, you might find it beneficial to incorporate it.

Ultimately, there are several factors to consider when deciding whether to choose a sole proprietorship vs. a corporation.

Find more information on how to start a corporation.

Sole proprietorship vs. corporation taxes

There are quite a few differences between the sole proprietorship business entity type and the corporate structure. One of those differences involves how each of these structures pays taxes.

Sole proprietorship taxes

  • Sole proprietors are responsible for reporting their business income and expenses on their personal income tax returns using the Schedule C Form.
  • Therefore, your business income is liable for federal and state income and self-employment taxes. When you’re an employee, your Social Security and Medicare taxes are subsidized partly by your employer, who also withholds the other half of your pay.
  • However, when you’re a sole proprietor, the full amount of Medicare and Social Security taxes fall on you solely.
  • Social Security and Medicare taxes are also known as self-employment taxes.
  • Additionally, estimated taxes on self-employment income must be paid by sole proprietors quarterly to avoid penalties, fees, and a huge tax bill in April of the following year.

Corporation taxes

  • You can decrease taxable income by ordinary business expenses when forming a corporation. All expenses needed for the competent and effective operation and running of the business are fully tax-deductible.
  • Any real estate or investments bought intending to bring in money for the company are also tax-deductible.
  • Corporations are also allowed to deduct employee salaries, bonuses, health benefits, and tuition reimbursement. Furthermore, they can choose taxable income by deducting travel expenses, interest payments, insurance premiums, bad debts, excise taxes, sales taxes, and fuel taxes.
  • The default corporation structure is liable for double taxation. This means that the company’s business income or business profits are taxed at the corporate level, and the shareholders are still taxed on the individual level on their portion of the dividends.
  • Corporations may elect the S corporation or S corp status, allowing business profits to pass through to the company owners.
  • The corporation will no longer be liable for corporate tax; however, each member or shareholder of the corporation will be liable for individual tax on their share of the profits.

Sole proprietorship vs. corporation: Formal requirements

The process of forming a corporation significantly differs from the process of forming a sole proprietorship. Let’s take a look at the key differences when it comes to formal requirements:

Formal requirements for sole proprietorships

  • When it comes to starting a sole proprietorship, there are no official forms or documents for that matter to submit or file with the state.
  • All you need to do is decide on a name for your sole proprietorship, and you can give your business another name aside from your own. However, you must register it with the appropriate authorities where you plan on conducting business.

Formal requirements for corporations

  • Starting a corporation requires you to fulfill certain legal obligations and requirements to maintain ongoing compliance.
  • Corporations must follow a few additional steps compared to forming a sole proprietorship.
  • Corporations must file the Articles of Organization or Incorporation with the secretary of state and create bylaws similar to an operating agreement when forming an LLC.
  • After that, a corporation is liable for filing annual reports, holding the annual shareholders meeting, and remaining in good standing by ensuring that business taxes, necessary filing fees, and so on are complied with.

Ongoing compliance

Corporations have more complex compliance requirements such as submitting annual reports, paying annual fees, renewing licenses and permits, holding annual shareholders’ meetings, keeping records of those meetings, etc. On the other hand, a sole proprietorship will simply need to renew its licenses and permits and pay its taxes.

Sole proprietorship vs. corporation: Management structure

Sole proprietorships and corporations are managed differently. Let’s take a look at the key differences:

Sole proprietorship management

  • The sole proprietor is the owner and the manager of his or her company.
  • He or she is responsible for making all management decisions affecting the business.
  • Starting when the business opens, the management duties involve setting the hours of operation and deciding the prices at which goods and services will be sold.
  • If you need to hire extra help, you’ll need to hold the interviews, hire the right candidates, and provide training and ongoing management for your employees.
  • Additionally, you will be solely responsible for this function as a sole proprietor when it comes to marketing or attracting additional business.

Corporation management

  • A C corporation or C corp is a type of business managed by a Board of Directors, officers, and shareholders.
  • These parties are responsible for the corporate governance and overall management of the corporation.
  • The board appoints the officers who are ultimately responsible for the day-to-day management and operations of the company.

Sole proprietorship vs. corporation: Ownership structure

One of the most striking differences between sole proprietorships and corporations is the ownership structure. So let’s take a look at the key differences:

Sole proprietorship ownership

  • Sole proprietorships are owned and operated by an individual who is also the business owner.
  • It’s one of the simplest business entities to form due to the flexibility of ownership and management.
  • Since the sole proprietor is also the manager of the business, there’s complete freedom in how the business is owned, operated, and managed daily.

  • A single individual or a married couple may own sole proprietorships.

Corporation ownership

  • Regarding corporations, ownership of the business is decided by who owns the shares.
  • Therefore, all the shareholders in a corporation are the actual owners, while the Board of Directors is responsible for the corporation’s management.

Summary

A sole proprietorship is the ideal business structure if you own and manage the business yourself. It’s also a good choice if you’re unsure whether you will be in that specific industry or business type over the long term. However, a corporation may be the better choice if you plan on growing your business and running it over the long run. Whether you start a sole proprietorship or corporation, consider all the factors, including the advantages and disadvantages, before making your final decision.

FAQs

When deciding to incorporate or form a sole proprietorship, you’ll need to determine which structure offers the most benefits. For example, incorporation provides greater liability protection than sole proprietorships or general partnerships.

One of the advantages that a sole proprietorship has over a corporation is the low start-up costs as well as maximum privacy. Additionally, the forming and running of your business is much simpler as you’re the only person involved in the decision-making process.

The disadvantages of a sole proprietorship include unlimited liability for the company’s obligations and debts, as there’s no legal distinction between the sole proprietor and the business. Additionally, keeping on high-caliber employees can tend to be a challenge.

Some of the disadvantages of incorporation include double taxation, the tedious and time-consuming formation process, and the rigid protocols and formalities that corporations need to follow.

A sole proprietorship is owned by one individual that is 100% liable for the company’s debts and obligations. A partnership is formed by a minimum of two people combining their resources and sharing losses and profits. On the other hand, a corporation is a separate legal entity with shareholders, and they enjoy more liability protection than the first two business structures.

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]]> What is the Difference Between an LLC and LLP? https://www.chamberofcommerce.org/difference-between-llc-and-llp Tue, 31 Jan 2023 10:35:58 +0000 https://www.chamberofcommerce.org/?p=29807 The first step in starting a new business is deciding on the most suitable business structure. Before deciding to start an LLC (limited liability company) or LLP (limited liability partnership), you must note that each type of business comes with its own benefits and drawbacks. Before making your choice, you should always look at the […]

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The first step in starting a new business is deciding on the most suitable business structure. Before deciding to start an LLC (limited liability company) or LLP (limited liability partnership), you must note that each type of business comes with its own benefits and drawbacks.

Before making your choice, you should always look at the potential limited liability, tax advantages, and ownership structure. Whether you start an LLP or LLC will depend on your business goals, the size of your business, and the flexibility you’re looking for when running your business.

Entity type
Liability
Taxation
Maintenance
Limited liability company
A pass-through tax structure combined with limited liability protection.
According to the IRS, LLCs may choose whether they want to be taxed as corporations or partnerships.
LLCs must hold annual meetings, record minutes of meetings, issue stocks to shareholders, and file individual state and federal income tax returns to remain compliant.
Limited liability partnership
Although LLPs offer limited liability protection, some states may vary on their definition and the regulations surrounding the liability protection afforded to LLPs.
LLPs are considered pass-through entities, and the company itself pays no taxes, while profits and losses are reflected on the partner’s personal income tax returns.
LLPs must file annual returns, financial statements, as well as income tax returns to remain in good standing.

What is an LLP?

An LLP is a general partnership formed by a minimum of two people referred to as the owners or partners. Much like an LLC, an LLP combines a partnership and a corporation where the partners enjoy some limited personal liability. Professional businesses are usually formed as LLPs.

LLP benefits

  • Straightforward formation process: While forming a limited liability partnership requires paperwork and filing fees, it’s a fairly straightforward process. An LLP owner must complete the documentation required by the Secretary of State’s office. Some documentation includes a Certificate of limited liability partnership and the filing fee that varies from state to state. Annual reporting may also be required and varies from one state to the next. However, it usually includes basic reporting such as your business address, registered agent’s name, and the number and names of partners in your company.
  • Taxation: Since limited liability partnerships are taxed as pass-through entities, LLP members must include profits and losses from the business on their personal tax returns.
  • Limited protection: In a limited liability partnership, each partner’s liabilities are limited to their investment or the amount of money they’ve put into the business.
  • Flexibility to evolve: As long as the partnership agreement allows for new partners to join and long-term members to move on, there should be no disruption to the business itself.

LLP drawbacks

  • Not allowed in every state: Some of the reasons why limited liability partnerships are not allowed in every state are due to the complex nature of tax filings with this business structure and the fact that it’s not regarded as a legal entity in many states. The states that allow LLP formations have restrictions on what type of professionals may set up an LLP and may impose heavy tax limits on them both during formation and throughout their operations.
  • Less credibility: LLPs have less credibility than other types of business entities. This is one of the reasons many entrepreneurs choose to form actual corporations as opposed to LLPs.
  • Partners don’t have to consult each other: Another drawback of a limited liability partnership is that the individual partners do not have to consult each other when conducting certain business activities.
  • Disclosure of financial records: One of the mandatory requirements is that financial records must be submitted for public record.
Read more about LLPs.

What is an LLC?

An LLC is a business entity that limits the liability of its owners, also known as members. While any business is allowed to create an LLC, you cannot have an LLC for professionals who require a license to operate.

A limited liability company is considered a hybrid business entity as it combines the characteristics of a corporation with that of a sole proprietorship or partnership. While both limited liability companies and corporations enjoy similar liability protections, the availability of flow-through taxation, also known as pass-through taxation to LLC members, is a feature that comes with partnerships rather than LLCs.

LLC benefits

  • Pass-through taxation: LLCs are not liable for taxes at the corporate level. Both profits and losses due are passed-through to the members for them to report on their personal income tax returns. Therefore, all taxes due are paid at the individual level.
  • Management structure: The management structure with LLCs is quite flexible. LLCs may choose to have the members manage the business, called a member-managed LLC. Alternatively, they can elect a manager from outside of the company to manage the business, called a manager-managed LLC.
  • Increased credibility: As opposed to forming a partnership or sole proprietorship, an LLC carries far more weight with clients, lenders, and suppliers. This is because LLCs are considered a formal business structure.
  • Flexible membership: Members of an LLC may be partnerships, individuals, corporations, or trusts, and there’s also no restriction on the number of members.
  • Limited liability: Members of an LLC are not held personally liable for the negligence of the company or other members. Therefore, the personal assets of LLC members are off-limits to creditors in case of business debts, malpractice, or lawsuits.
  • Limited compliance requirements: In terms of ongoing maintenance and compliance, LLCs must adhere to fewer state-imposed compliance requirements and ongoing filings compared to other business entities.

LLC drawbacks

  • Transfer of ownership: Transfer of ownership with corporations is often an easier process compared to LLCs. So unless the operating agreement allows it, all LLC members must consent or approve the addition of new members and any changes in the ownership percentages of existing members.
  • High costs: Unlike forming a general partnership or sole proprietorship, LLCs tend to cost more to create and maintain. Aside from the initial formation fee, LLCs are subjected to ongoing maintenance fees such as franchise tax and annual reporting fees.

At a glance: How is an LLC different from an LLP?

Let’s take a look at the key differences between Limited liability companies and limited liability partnerships:

  • In some states, limited liability partners are shielded from liability if another partner faces negligence or malpractice claims.
  • Regarding taxation, LLCs are afforded more options than LLPs, such as electing to be taxed as an S corp.
  • When forming a limited liability partnership, only individuals are allowed to be partners compared to creating an LLC, where other partnerships or trusts can also be members of the company.
  • While LLCs are allowed to have a single owner, LLPs must have a minimum of two owners. Hence, it is referred to as a “partnership.”

LLC vs. LLP: Taxes

One of the biggest advantages or disadvantages of any business is how the different structures are taxed. For example, when it comes to paying taxes on an LLC and LLP, it’s different with both entity types. So let’s take a closer look at LLC taxes vs. LLP taxes.

LLC taxes

  • LLCs may be taxed as partnerships, sole proprietorships, C corporations, and S corporations.
  • Single-member LLCs are taxed as sole proprietorships.
  • One of the best structures to elect is the S corp status, which allows you to maintain pass-through taxation. (However, you’ll greatly reduce self-employment taxes.)
  • Many people choose to elect the S Corp status because members of an S Corp are only liable for Medicare and Social Security taxes on the income taken as salaries.
  • Dividends or any income taken as distributions are not liable for self-employment taxes.

LLP taxes

  • Regarding tax purposes, the Internal Revenue Service (IRS) sees LLPs as pass-through entities.
  • Ultimately, this means that the profits and losses of LLPs are reflected on the business partners’ personal income tax returns.
  • So the limited liability partnership itself is not liable to pay corporate taxes.
  • LLPs must also file annual information returns to report their operations’ gains, losses, income, deductions, etc.
Read more about LLC types.

LLC vs. LLP: Formal requirements

The formation requirements for both LLCs and LLPs have similarities as well as differences:

Formal requirements for LLCs

  • When forming an LLC, the Articles of Organization, often called the Certificate of Organization, must be filed with the state along with payment of the relevant filing fees.
  • Additionally, LLCs should have an operating agreement at their place of business.
  • While this is not compulsory, it will come in handy in resolving disputes between members somewhere down the line.
  • Therefore, the operating agreement, if one is drawn up, does not need to be filed with the Secretary of State’s office. However, it must be kept on record for reference, as and when needed.
  • Some states may also require that LLCs publish a newspaper notice to inform the public of the limited liability company’s formation and ownership.

Formal requirements for LLPs

  • When forming an LLP, partners of the LLP must file the required business registration documents and pay the relevant filing fees with the state agencies.
  • LLPs should preferably have a written partnership agreement.
  • As with the operating agreement for LLCs, the partnership agreement does not need to be filed with the Secretary of State’s office. However, it must be kept at the LLP’s place of business.
  • Some states might also require that LLPs publish a copy of their registration or the notice of formation in newspapers.

Ongoing compliance

Regarding other business structures such as corporations, LLCs and LLPs have minimal ongoing business compliance requirements. Once again, this may vary from one state to the next and may also be based on the LLC’s operating agreement or the LLP’s partnership agreement.

However, some ongoing compliance requirements for LLCs and LLPs may include filing annual reports with the state, maintaining the operating and partnership agreements at the desired address, maintaining a registered agent, reporting and paying estimated income taxes, and renewing licenses and permits.

LLC vs. LLP: Management

LLCs and LLPs are fairly easy to manage, with the majority of flexibility stemming from the operating agreement and partnership agreement:

Management flexibility for LLCs

  • Owners of a limited liability company are considered members. Additionally, LLCs may be manager-managed or member-managed.
  • How the decision-making process, as well as the management process, is structured comes with a great deal of flexibility.
  • It’s important to create an operating agreement so that the management structure, as well as the rights and responsibilities of the members, may be detailed and put on file.

Management flexibility for LLPs

  • Owners of a limited liability partnership are known as partners.
  • LLPs come with great flexibility regarding how the business is managed.
  • Additionally, the profit-sharing, rights, and duties, as well as the operation structure itself, are all outlined and contained in the partnership agreement.

LLC vs. LLP: Ownership structure

The ownership criteria for both LLCs and LLPs differ, and state laws play a huge role in the restrictions and limitations on what type of business structure you may form:

Ownership structure of LLCs

  • An LLC is allowed to have one (single-member LLC) or more owners (multi-member LLC).
  • These members may be individuals, corporations, other LLCs, or foreign entities. However, depending on the state laws or requirements, certain types of businesses may be restricted from forming an LLC.
  • In most cases, when certain types of companies and certain types of licensed professionals are not allowed to start LLCs in a specific state, they usually allow you to start a PLLC or professional limited liability company instead. PLLCs are for professionals who require a license to operate, such as architects, accountants, and lawyers.
  • The LLC operating agreement ultimately ensures that the percentage of ownership and the responsibilities and roles of all members are documented.

Ownership structure of LLPs

  • Limited liability partnerships are allowed to have at least two or more partners.
  • The business management is ultimately left to all the company’s partners.
  • Likewise, all of the partners experience limited personal liability.
  • In certain states, such as California, only certain licensed professionals, such as architects, lawyers, and accountants, may form an LLP.
  • A partnership agreement is crucial to documenting the responsibilities, goals, and ownership percentage.

Summary

Selecting the correct legal structure for your business is one of the more important decisions you will make at the onset. Remember to always compare the advantages and disadvantages of asset protection, ownership, and control, as well as costs and taxation.

You may also find that you’re limited to your choice of a legal entity based on the type of industry you’re in and the state laws you are required to comply with. Ultimately, note that each business structure or entity type has benefits and drawbacks, and there are better choices than one entity type.

FAQs

When deciding on an LLC or LLP business structure, you must consider some factors, including liability, taxes, ownership, and management. You also need to keep your business goals in mind and ensure that the structure will work for you in the long run.

While limited liability companies and limited liability partnerships are two common structures, and they may sound very similar, their differences exist. The best way to find out your state’s specific legal and filing requirements is to check on the Small Business Administration’s website (SBA).

The owners of a limited partnership (limited partners) have less liability and are not involved in the day-to-day activities or operations of the company. General partnerships (general partners), on the other hand, have full operational control of the business as well as unlimited liability.

Double taxation is when a company is taxed on the corporate level as well as on the individual level. For example, C corporations are subject to taxation on their corporate income, and the owners are also liable for submitting tax on their personal tax returns.

Silent partners have the opportunity to invest money into a business. However, they cannot fulfill or take an active role in the company’s day-to-day operations or management decisions. Therefore, a silent partner’s only contribution is their funding to the business.

A sole proprietor is an individual who owns and controls a business with no partners involved. A sole proprietor is not a separate legal entity from the business itself and therefore is liable for all the profits and losses from the company.

The post What is the Difference Between an LLC and LLP? first appeared on Chamber of Commerce.

]]> LLC vs Sole Proprietorship: What is the difference? https://www.chamberofcommerce.org/llc-vs-sole-proprietorship Tue, 31 Jan 2023 10:32:41 +0000 https://www.chamberofcommerce.org/?p=29621 When deciding on a business entity type, you need to consider whether you’ll own the business with a partner or run your business solo. In such cases, a limited liability company [LLC] or sole proprietorship would be a good choice; however, you need to be aware of the advantages and disadvantages of each. The following […]

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When deciding on a business entity type, you need to consider whether you’ll own the business with a partner or run your business solo. In such cases, a limited liability company [LLC] or sole proprietorship would be a good choice; however, you need to be aware of the advantages and disadvantages of each. The following guide will outline the differences between sole proprietorships and LLCs to help you make an informed decision.

What is a sole proprietorship?

When an individual (or legally married couple) creates a business, it is considered a sole proprietorship by default. One of the advantages of sole proprietorships is that no formation documents are required to be filed with the state. The owner (sole proprietor) and the small business are regarded as the same legal entity and tax-paying entity.

Sole proprietorship benefits

  • Less stringent filing requirements: When starting a sole proprietorship, you won’t have to fill out a ton of paperwork as compared to starting a corporation, limited liability company, or limited liability partnership. This is because you won’t need to register with the state, and you can form your business entity by virtue of doing business. However, you may have to obtain certain licenses and permits depending on the requirements laid down by the state or local government.
  • Low filing fees: Many business structures need to register with the state and pay annual filing fees to maintain the registration. Sole proprietorships do not have the same ongoing legal requirements, which allows them to save on filing fees and time.
  • Easy tax setup: Sole proprietorships have straightforward tax requirements compared to other entity types. You won’t need to apply for an EIN because you will be allowed to use your Social Security number like you would for any other financial transaction that requires it. Sole proprietors are taxed as pass-through entities, so you are taxed on a personal or individual level and don’t have to worry about submitting separate taxes for the business.
  • Simple ownership structure: As the sole owner of your business, you have total control over the finances and decision-making process.
  • Straightforward banking: When you start a sole prop, you won’t need to open up a separate or corporate bank account to operate. You can accept payments straight to your personal bank account.

Sole proprietorship drawbacks

  • Hard to sell the business: While it is not impossible to sell a sole proprietorship, you’ll need to sell the business differently. This means selling your business assets rather than the business itself since the sole prop is attached to an individual by nature. This also means that if you no longer want to run the company or you pass on, the business comes to an end.
  • Hard to obtain credit and financing: It can be challenging for sole proprietors to build business credit in the same way as other business entities that are well established and have a larger revenue. In terms of securing credit, it’s completely dependent on the sole proprietor’s initial investments, credit history, and finances.
  • No liability protection: Since sole proprietors do not register their business with the state, they are also not afforded any type of liability protection. So in terms of business debts and obligations, personal assets will most likely be used to pay off creditors.

What is an LLC?

Limited liability companies are legal business entities formed under state laws and require formal registration. LLCs with only one member, known as single-member LLCs, can be compared to sole proprietorships. This is because the owners are known as members.

When more than one member is involved, it’s called a multi-member LLC. Multi-member LLCs can be managed by the company’s members or by a manager hired outside the company and designated by the LLC members.

LLCs are also considered separate legal entities from their owners and, by default, are considered the same tax-paying entity.

LLC benefits

  • Lenient ongoing compliance: When creating and maintaining an LLC in the long run, fewer requirements are involved compared to other business structures like corporations.
  • Personal liability protection: The LLC business structure is appealing to many small business owners and entrepreneurs due to the personal liability that it offers to all members. So in the event of debt, obligations, and lawsuits, the owner’s personal assets cannot be used to pay off what the company owes.
  • Flexible ownership: LLCs can be owned by partnerships, trusts, corporations, foreign entities, and individuals. There are also no restrictions on the number of members or owners an LLC can have.
  • Credibility: LLCs are seen as a more formal business entity when compared to partnerships and sole proprietorships. Therefore they have much more credibility with clients, financial institutions, and suppliers.
  • Management flexibility: LLCs may choose to be managed by the members or by nominating an individual from outside the company to manage the LLC’s day-to-day operations.
  • Pass-through taxation: Another benefit of LLCs is that members enjoy pass-through taxation. They will submit personal income tax returns on the incomes and losses of the company. LLCs are not liable for corporate taxes.

LLC drawbacks

  • Transfer of ownership: Unless an operating agreement is drawn up stating that new members can be brought into the company without prior consent from all members, this task will become a challenge if everyone in the company is not on board.
  • High formation and maintenance costs: It costs far more to form and maintain an LLC when compared to a sole proprietorship or partnership. Additionally, LLCs, like corporations, will have to fork out formation fees, annual reporting fees, ongoing filing fees, and the necessary fees for renewing licenses and permits and submitting taxes.

At a glance: How is a sole proprietorship different from an LLC?

Both sole proprietorships and LLCs have their similarities as well as their differences.

  • Sole proprietorships are more cost-effective in terms of formation and also much easier to maintain.
  • Owners are also taxed at the relevant individual personal income tax rates on profits the company makes in the sole proprietorship business structure.
  • LLC owners are protected as LLCs provide personal liability protection against the debts, judgments, or lawsuits brought against the business. It’s, therefore, a form of legal protection.
  • A few additional steps are also involved in forming an LLC instead of a sole proprietorship.
  • LLCs must complete formation documents, register with the state, pay filing fees, and follow state laws governing this type of business.
  • They are responsible for filing annual reports, paying state fees, and holding annual meetings.
  • LLCs must also ensure that the company’s records and funds are separated from individual or personal bank accounts.
  • In terms of taxes, LLCs can choose to be taxed as partnerships or sole proprietorships, as well as S corps and C corporations.

Should I start a sole proprietorship or LLC?

You are not alone if you’re unsure whether to start a sole proprietorship or an LLC. The best way to decide is to know what each business structure requires and how each business structure may restrict you. If you plan on expanding the business and having more than one owner sometime in the future, you’re safer with an LLC.

Additionally, an LLC is a way to go if you want your personal assets protected from potential legal and financial liability. Forming an LLC is highly recommended if you want to enjoy the business tax benefits that come with limited liability companies, be it on the local, state, or federal level.

While the startup costs when starting a sole proprietorship are low, and you maintain maximum privacy, as the company owner, you are regarded as the company itself and 100% responsible for any business debts, judgments, or lawsuits brought against your company. So let’s take a closer look at how sole proprietorship and LLC taxes differ.

Read more about LLC types.

Sole proprietorship vs. LLC taxes

Regarding LLC vs. sole proprietorship, there are differences in how these business entities operate and pay taxes. Let’s examine how taxes are paid for both business structures.

Sole proprietorship taxes

  • Sole proprietorships are not seen as corporate tax-paying entities. A sole proprietor’s taxable business income is subject to tax rates for individuals.
  • Its losses and income are passed-through to the owner’s personal tax return via IRS or Internal Revenue Service Schedule C.
  • The income generated by the sole proprietorship is also subject to self-employment taxes such as Social security and Medicare.
  • Sole proprietorships must make quarterly estimated tax payments to the state, U.S. Treasury, and in some instances, the local tax authority because Medicare, Social Security, and income tax are not deducted from a salary or paycheck from an employer.

LLC taxes

  • LLCs are seen as disregarded entities unless the LLC owner makes a special tax election.
  • LLCs are not recognized as their own tax-paying entity. The business obligations of the company go through to the LLC owner.
  • If an LLC meets the eligibility requirements, it may choose to opt for corporate tax treatment as either a C or S corporation.
  • This significantly reduces the self-employment tax burden as Medicare and Social Security are only applied to the owners’ salary or wages rather than to taxable business income.
  • If electing C Corp status, the business files its own income tax returns, and the profits of the business are taxed at the corporate tax rate.
  • This can be a drawback for some LLCs because profits will get taxed twice, once at the corporate level and then again at the individual level.
  • However, income tax obligations pass through to the owner’s personal tax returns when electing the S Corp status.
  • Many LLC owners choose to elect the S Corp status as it is more favorable regarding tax purposes.

Sole proprietorship vs. LLC: Formal requirements

Sole proprietorships have far fewer formal requirements when compared to LLCs. Let’s take a look at the requirements below:

Formal requirements for sole proprietorships

  • Sole proprietorships do not need to register with the state before transacting.
  • Depending on the industry they are involved in, they may need to obtain specific licenses and permits before operating.
  • No formal action is required if you are operating under your name. However, you will need to file a DBA (doing business as) if you plan on conducting business under a different business name from your legal name.
  • In some cases, you may need to acquire the necessary permits and business licenses, which will vary based on your industry, state, or region.

Formal requirements for LLCs

  • When starting an LLC, you’ll need to file Articles of Organization, also referred to as the Certificate of Organization, with your Secretary of State.
  • It’s also a good idea to have your LLC operating agreement drawn up to ensure that the rights and duties of all members and managers are clearly outlined.
  • LLCs also require you to file documentation with state agencies and pay initial filing fees.

Ongoing compliance requirements

When running a sole proprietorship, there are no registration or ongoing filing requirements, so there are no corporate formalities or paperwork requirements. Business begins when you start transacting. LLCs have quite a few compliance requirements when compared to sole proprietorships. This is because LLCs will need to file annual reports with the Secretary of State, make payments of state fees and franchise taxes, and file income taxes with the Internal Revenue Service.

Sole proprietorship vs. LLC: Management structure

The management structure for a sole proprietorship vs. LLC differs significantly. Let’s take a look at it below:

Sole proprietorship management structure

  • When it comes to sole proprietorships, the owner is the company itself, and therefore the company owner manages day-to-day operations.

LLC management structure

  • One or more members can own LLCs.
  • Additionally, owners or members of the LLC are allowed to manage the day-to-day operations of the limited liability company, or they can choose to nominate a manager outside of the LLC to handle the company’s operations.

Sole proprietorship vs. LLC: Ownership structure

The ownership structure of a sole proprietorship differs significantly from that of an LLC. Let’s take a closer look at the differences below:

Sole proprietorship ownership

  • Sole proprietorships are owned and maintained by one individual. So the ownership structure is very straightforward.
  • In some instances, married couples may also run a sole proprietorship.
  • While sole proprietorships are entitled to all the company profits, they are also liable for all the debts and judgments associated with the company.

LLC ownership

  • Partnerships, trusts, corporations, foreign entities, and individuals can own LLCs. There are also no restrictions on the number of members or owners an LLC can have.
  • LLCs are considered separate entities or separate legal entities from their owners and are not held personally liable for the debts, judgments, or lawsuits brought against the business.
  • So in the case of LLCs, personal and business assets are separate.

Summary

Depending on your new business goals and industry, and the benefits you are after, be it simplicity in formation, compliance, or liability protection, both sole proprietorships and LLCs have advantages and disadvantages.

For some business owners, the fact that they are personally or legally protected from financial claims against the company is more than enough reason to go with the limited liability company.

However, if you value the independence and privacy that comes with the sole proprietorship entity type, and the fact that it’s a fairly fast and simple structure to get up and running, then the choice is yours.

To make an informed decision, research the requirements and limitations associated with LLCs and sole proprietorships.

FAQs

Sole proprietorships are regarded as common-law business entities, so they don’t have to file formal paperwork with the state or need a registered agent.

A sole proprietorship is regarded as an unincorporated business having only one owner. However, taking on a business partner in a sole proprietorship is possible, thereby altering your entity from an unincorporated business to a general partnership.

A sole proprietorship is ideal for entrepreneurs and low-risk businesses that simply want to test their business ideas before formal registration with the state. However, when it comes to the risks of remaining unincorporated, you will need to consult with an attorney.

Sole proprietorships do not need to undergo formal registration requirements with the state. However, depending on the services offered or the industry, you must acquire the necessary licenses and permits before operating.

The sole proprietor or owner of the sole proprietorship is responsible for all expenses associated with the business. This means creditors may attach both fixed and personal property if the business owes money. Sole proprietorships do not have a separate identity under the law.

The post LLC vs Sole Proprietorship: What is the difference? first appeared on Chamber of Commerce.

]]> LLC vs Corporation: What’s the difference? https://www.chamberofcommerce.org/llc-vs-corporation Tue, 31 Jan 2023 10:22:56 +0000 https://www.chamberofcommerce.org/?p=29489 One of the first steps in starting a new business is deciding on a business structure or entity type. Choosing the proper structure is imperative to your business’s success, as the right structure will suit your business needs, size and goals. However, deciding on the right structure, be it a limited liability company or corporation, […]

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One of the first steps in starting a new business is deciding on a business structure or entity type. Choosing the proper structure is imperative to your business’s success, as the right structure will suit your business needs, size and goals.

However, deciding on the right structure, be it a limited liability company or corporation, will also depend on the type of business you plan on creating, the tax consequences of forming that specific entity, and so on.

The following guide will explain the differences between an LLC and a corporation and ultimately help you decide the best business structure.

Entity type
Liability
Taxation
Maintenance
Limited liability company
A pass-through tax structure combined with limited liability protection.
According to the IRS, LLCs may choose whether they want to be taxed as corporations or partnerships.
In terms of maintenance, an LLC is one of the easiest entity types to maintain due to the minimal amount of formal annual requirements.
Corporation
When it comes to business-related debts, the shareholders or owners have limited personal liability.
Corporations are considered separate taxable entities, and corporate profits are taxed among owners and the corporation.
In order to raise capital, stock may be sold. In order to maintain corporate status, meetings need to be held.
S corporation
S corporation is ultimately a tax status. This means that any existing liability protections from your base entity carry over.
Additionally, S corporations are costlier to set up than sole proprietorships and partnerships. However, they do offer considerable tax savings.
S corporations require more formality and paperwork, whereas a limited liability company is one of the easiest entities to form and still offers similar advantages to S corporations.
Nonprofit corporation
Nonprofit corporations are created for charitable, religious, educational, scientific, or literary purposes.
All contributions made to nonprofit corporations are tax deductible. Additionally, nonprofits may attain tax-exempt status with the IRS.
In order to maintain a nonprofit or tax-exempt status, you’ll need to submit annual reports, record minutes of meetings, hold regular meetings, etc.

What is an LLC?

An LLC or limited liability company is a type of business that provides its owners (referred to as members) with limited liability protection.

This means that when the business incurs debt or obligations or is faced with lawsuits, the members’ personal assets cannot be used to pay off these debts.

A limited liability company is a hybrid business entity combining the characteristics of a sole proprietorship or partnership with corporations.

LLC benefits

  • Management flexibility: LLCs have a flexible management structure that allows them to choose how they manage the business. LLCs may be member-managed (run by the members) or manager-managed (run by a manager hired from outside the business).
  • Credibility: LLCs have more credibility with suppliers, lenders, and clients than other business entities like partnerships or sole proprietorships. This is because LLCs are regarded as more formal business entities.
  • Flow-through taxation: LLCs are not liable for corporate taxes. Instead, the company’s income and expenses are passed through to the members so they can report them on their individual income tax returns.
  • Membership flexibility: LLCs may be owned by individuals, partnerships, trusts, or corporations, and there’s no restriction on the number of members an LLC can have. 
  • Limited compliance requirements: While LLCs are still required to adhere to annual reporting requirements, they are subject to fewer ongoing filings and compliance requirements imposed by the state compared to other types of business structures, such as corporations.
  • Limited liability: In the event of lawsuits, malpractice, or business debts and obligations occur, creditors cannot seize the personal assets of members to pay off the company’s debts. This is because LLC members are not personally liable for negligence by the company or other members, for that matter.

LLC drawbacks

  • Higher formation and compliance costs: Forming a sole proprietorship or general partnership is cheaper than forming an LLC. LLCs pay higher filing fees for both the initial formation as well as the ongoing maintenance of the company.
  • Transfer of ownership: Corporations have a much easier process to transfer ownership than LLCs. This is because, in an LLC, all members must consent to the addition of new owners or members or changes in percentages of ownership of current members unless the operating agreement clearly states that they don’t have to.
Read more about LLC types.

What is a corporation?

A corporation is considered a separate legal entity created by shareholders, stockholders, or individuals to generate profit. Corporations are allowed to own assets, enter into contracts, borrow money from banks and other financial institutions, and remit state and federal taxes.

To form a corporation, you’ll need to go through a legal process called incorporation. This process involves submitting legal documentation and filing the necessary forms with the relevant federal and state agencies.

Ultimately, the incorporation process ensures that the entity is protected from personal liability in case of a legal claim or lawsuit.

Corporation benefits

  • Personal liability protection: When compared to any other entity type, a corporation offers more personal asset or liability protection. If a corporation is sued, the owners cannot be held personally responsible for the company’s debts and obligations.
  • Access to capital: Corporations may easily raise funds by selling stock since they sell ownership through publicly traded stock. Corporations have easy access to funding, which comes in handy for growing the company and saving the business from going bankrupt in times of need.
  • Perpetual existence: The ownership of a corporation depends on the percentage of stock ownership, thereby granting owners more flexibility than any other business structure in terms of perpetuating the business over the long term and transferring ownership.
  • Tax benefits: While the default corporation structure, known as the C Corporation structure, is liable for double taxation, corporations are allowed to elect the S corporation status, meaning that they can determine how their income will be distributed and consequently taxed.

Corporation drawbacks

  • Strict formal requirements: The overall process of incorporating can be quite lengthy. You have to go through extensive paperwork and filing to properly document the details of your company as well as its ownership. You’ll need to create bylaws and a shareholders’ ownership change agreement, appoint a board of directors, take minutes during meetings, issue stock certificates, etc.
  • Double taxation: Double taxation comes with the default corporation structure, the C corp. Double taxation means that the business is taxed at the corporate tax rate as well as the individual level since the shareholders will also have to pay taxes on their personal income tax returns. The only way to avoid double taxation is to elect the S corporation status.
  • Rigid structure: Aside from the strict requirements during the application process, many formal and legal requirements are involved in maintaining a corporation. Some of those stringent requirements include maintaining a board of directors, following your company’s bylaws, holding annual meetings on time, submitting annual reports, and paying the necessary annual fees to remain in good standing.
  • High cost: Corporations are not the cheapest entity type to form and operate, not to forget the payment of ongoing fees, filing charges, and taxes.
Read more about corporations.

How is an LLC different from a corporation?

Both LLCs and corporations are different in a few ways. Let’s take a look at the differences below:

  • Both business structures require you to file business formation documents with the state, but corporations have stricter formation requirements than LLCs.
  • There is a lot more ongoing compliance paperwork, filing, and reporting requirements for corporations vs. LLCs
  • However, corporations tend to have a more standardized and robust operating structure, but it also comes with more record-keeping and reporting requirements than LLCs.
  • Ultimately, there is more flexibility in running a limited liability company than there is in running a corporation.

LLC vs. corporation taxes

Regarding taxes, LLCs have quite a few options compared to corporations. This is because limited liability companies are not restricted to one tax classification by the IRS and may choose to be taxed as partnerships, sole proprietorships, S corporations, or C corporations.

LLC taxes

  • LLCs do not pay corporate income tax; instead, the profits and losses of the business are passed through to the members, who will report this on their personal tax returns.
  • LLCs may elect to be taxed as an S corporation.
  • LLC members are not subject to Social Security or Medicare taxes since they are not considered employees. The only exception to this rule is when a member actively works in the business, and if so, they are not liable for self-employment taxes, including taxes on their salary and share of any profits.
  • LLC members working for the business may deduct the company’s operating losses on their individual tax returns to offset other income.

Corporation taxes

  • Corporations must submit tax returns and pay income taxes on their income or profits. This often leads to double taxation, where the corporation is taxed on profits, and owners are taxed on their share of the profits.
  • To avoid double taxation, corporations may elect the S corporation status, where they’ll be taxed as pass-through entities.
  • However, shares in a corporation are much easier to transfer than an ownership or membership interest in a limited liability company. So if you’re looking for outside investors, the corporation would be your best business structure.

Should I start an LLC or a corporation?

When deciding which business entity type is better for your company, you must consider several factors, including tax benefits, liability protection, and the various benefits of each business structure.

To select an entity that best meets your business goals, you’ll need to consider the differences between these two business structures, such as management, maintenance requirements, taxation, etc.

LLC vs. corporation: Formal requirements

Whether you’re forming an LLC or a corporation, you will be required by the state that you’re forming in to fulfill certain reporting and maintenance requirements. This allows the business to remain in good standing and manages the limited liability protection acquired by incorporation.

Formal requirements for LLCs

  • Limited liability companies have far fewer record-keeping requirements than corporations.
  • LLCs are not required to hold annual meetings, keep minutes or have a Board of Directors. They do still need to nominate a registered agent or registered agent service.
  • They may need to create Articles of Incorporation, Articles of Organization, or operating agreements. Some states may require annual reports. However, many of them do not.

Formal requirements for corporations

  • Corporations tend to have more annual requirements than limited liability companies, even though state law varies from one state to the next.
  • Corporations must hold an annual shareholders meeting once a year, and these details must be documented, including discussions as notes referred to as corporate minutes.
  • Additionally, corporations must have bylaws and submit annual reports which keep the business information up to date with the Secretary of State.

Ongoing compliance

For LLCs and corporations to remain in good standing, they will need to keep tax payments current and file income taxes with the IRS on time.

Additionally, ongoing compliance requirements dictate that both LLCs and corporations file annual reports, keep their business information up to date, maintain a statutory agent, and renew licenses and permits.

Failure to adhere to the ongoing compliance requirements in the state of formation could mean that your company is no longer in good standing.

LLC vs. corporation: Management

In terms of management structure, a corporation’s management structure is far stricter than an LLC. This is because corporations have a formal structure and, therefore, must have a Board of Directors that maintain and manage the responsibilities of generating profits for the shareholders.

Corporation management

  • With corporations, the business’s day-to-day operations are assigned to corporate officers, and the shareholders are also considered owners of the company but remain separate and uninvolved in the business’s decision-making process.

LLC management

  • LLCs have a much more workable management structure, and this business type may be managed by its members or a group of managers.
  • Any limited liability company member may fulfill the role of an LLC manager.
  • Additionally, an LLC may choose to elect to have no differentiation between a manager and a business owner. So this business type is very flexible.
  • LLC management is more informal, making it ideal and appealing for many entrepreneurs.

LLC vs. corporation: Ownership structure

Before starting an LLC or corporation, business ownership is yet another crucial aspect you must bear in mind. This is because the ownership structure in each business type differs, and each has transparent grounds, making your choice easier.

LLC ownership structure

  • A limited liability company can dispense its ownership stake to the owners without speculating on a member’s monetary allowance to the company itself.
  • Individuals, trusts, and other types of corporations may also own LLCs. Therefore, it’s the ideal option for businesses when these factors are significant.

Corporation ownership structure

  • Corporations sell percentages and issue shares of stock to owners or shareholders. Shareholders, in turn, may transfer the shares, purchasing additional stock to possess a larger percentage of the business or selling stock off to own a smaller percentage.

Summary

LLCs and corporations have benefits, such as providing limited liability protection for owners’ assets and separating the owners from the business. The first step is deciding which business structure or type most aligns with your business goals.

In a nutshell, LLCs offer a simple management structure, less paperwork, no double taxation, and the option to distribute ownership freely.

On the other hand, corporations offer a formal management structure, the ability to raise capital by issuing stock, tax-deductible fringe benefits, and ownership represented by the stock.

FAQs

C corporations are classified as separate legal entities and are subject to double taxation unless they elect S corporation status. Double taxation means the business is taxed at the corporate level, and the owners are also liable for taxes on their personal income.

The owners of an LLC may share in issuing the business’s profits and losses. Additionally, they are entitled to the LLC’s asset distributions at the time of existence and when it liquidates or dissolves.

Single-member LLCs are LLCs with only one owner compared to multi-owner LLCs with several owners, also known as members. However, single-member LLCs and Multi-member LLCs share the same benefits, such as pass-through taxation, perpetual existence, and limited liability. Additionally, they share the same drawbacks, such as a lack of investor appeal and higher formation costs compared to a corporation.

Self-employment tax is a federal tax placed on a self-employed person’s income. However, it is not a federal income tax. Owners of LLCs, sole props, and general partners must pay self-employment tax (social security and medicare tax).

For an LLC to be treated or regarded as an S corp by the IRS, they’ll need to file Form 2553, and if approved, they will elect the S corp status and enjoy the tax benefits that come along with it.

The post LLC vs Corporation: What’s the difference? first appeared on Chamber of Commerce.

]]> LLC vs S Corp: What is the difference? https://www.chamberofcommerce.org/llc-vs-s-corp Tue, 31 Jan 2023 08:22:03 +0000 https://www.chamberofcommerce.org/?p=29589 Deciding on the right entity type is imperative to the success of your business. Each business structure comes with its own set of advantages and disadvantages. Therefore, the type of structure you choose will all depend on your company’s goals, size, and the benefits you would like to enjoy. For example, limited liability companies and […]

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Deciding on the right entity type is imperative to the success of your business. Each business structure comes with its own set of advantages and disadvantages. Therefore, the type of structure you choose will all depend on your company’s goals, size, and the benefits you would like to enjoy. For example, limited liability companies and S corporations are quite popular entity types since each offers liability protection and tax advantages. The following guide will outline the differences between an LLC vs. an S corporation and ultimately help you make an informed decision.

What is an LLC?

A limited liability company is a legal business entity formed under state laws. LLCs require formal registration, and when one member is involved, it’s known as a single-member LLC. However, when more than one member is involved, it’s called a multi-member LLC. In a multi-member LLC, the option to have the company managed by members or an outside manager is available. Ultimately, an LLC is a separate legal entity from its members and, by default, enjoys the same tax-paying status.

LLC benefits

  • Protection of personal assets: Entrepreneurs and small business owners find the LLC business structure appealing because it offers protection of personal assets, also known as personal liability protection.
  • Credibility: Since LLCs are seen as more formal business structures, they have more credibility with financial institutions, clients, and suppliers.
  • Flexibility of ownership: LLCs can be owned by individuals, partnerships, corporations, trusts, and foreign entities. Additionally, an LLC can have any number of members.
  • Ongoing compliance: When compared to corporations, LLCs have much more leniency regarding ongoing compliance requirements.
  • Pass-through taxation: LLCs are taxed at the individual level, and the members of the LLC will submit personal income tax returns as opposed to the company submitting corporate taxes.
  • Management structure: LLCs may be managed by the owners or members; alternatively, they may need to hire an individual not a part of the LLC to maintain day-to-day operations.

LLC drawbacks

  • LLC costs: When compared to forming a sole proprietorship or partnership, it costs far more to form an LLC. Additionally, there are ongoing annual fees and filing fees associated with LLCs.
  • Transfer of ownership: While it’s possible to have new members brought into the company continuously, the consent of existing members must be given. The only way to avoid this is to have an operating agreement that states that new members can be brought on without prior consent from existing members.
Read more about LLC types.

What is an S corporation?

An S Corporation is a tax classification rather than a business entity type. Both corporations and LLCs may be taxed as S corporations. One of the major differences between S corporations and normal corporations or LLCs is that S corps do not pay corporate income tax as traditional C corporations do. Instead, business profits are passed through to the owner’s personal tax returns.

To experience the tax benefits or tax savings afforded by an S corporation, you must meet certain criteria, such as:

  • You can only have one class of stock.
  • Shareholders are not allowed to be non-resident aliens, partnerships, or corporations.
  • Shareholders may be individuals and certain estates and trusts.
  • There cannot be more than 100 shareholders or small business owners.
  • You must be a U.S. business.

Both corporations and LLC entity types can enjoy the benefits of S corporate taxation. Therefore, if you’ve formed a corporation, you can elect S Corp status, allowing you to avoid company profits taxed at both the corporate and shareholder level. Additionally, if you’ve formed an LLC, you can still elect the S Corp tax status allowing you to be considered a company employee and potentially saving you money on taxes.

S corporation benefits

  • Ease of conversion: For S corporations to be taxed as C corporations, they need to elect the C corp status with the IRS.
  • Salary and dividend payments: S corporations are entitled to receive both the dividend and salary payments from the corporation, resulting in lower tax bills overall.
  • Flow-through taxation: One of the major benefits of electing S corporation status is the flow-through taxation benefits. It entitles you to have tax deductions, losses, credits, and so on pass-through to the owners rather than the corporation being taxed at the business level. Therefore S corporations help you to avoid double taxation.
  • Asset protection: Limited liability protection is one of the main advantages of S corporations, irrespective of tax status. So the owners’ personal assets are shielded from any claims, debts, and obligations brought against the company.

S corporation drawbacks

  • S corp status requirements: There are strict requirements for electing the S Corp status. If these requirements are not met, you won’t be approved to operate as an S Corp.
  • Corporate formalities: The default structure of an S Corporation is a C corporation. Therefore, they must go through all the formal requirements for creating and maintaining a corporation. When compared to an LLC, corporations have far more statutory formalities.
  • Profit and loss allocation: How profits and losses are allocated is far more strict when compared to the way an LLC can allocate profits and losses. With S corporations, the losses and profits must be distributed amongst the shareholders and depend on the ownership percentage.
  • Membership limitations: S corporations cannot have more than 100 shareholders.

At a glance: How is an LLC different from an S corp?

  • When compared to a partnership or sole proprietorship, an LLC is a more formal business structure.
  • Most people use the terms LLC and S corporation interchangeably; however, they refer to two different aspects of the business. While an LLC is a legal business entity or legal entity, an S corporation is more of a tax classification.
  • When a business decides to elect S corporation status, it lets the Internal Revenue Service (IRS) know that the company must be taxed as a partnership.
  • To elect S corporation status, your company must register as a C Corporation first or an LLC and meet certain criteria set out by the Internal Revenue Service to qualify for this tax classification.

Should I start an LLC or S corporation?

A limited liability company, also called an LLC, is a type of legal entity used when creating a business. When compared to a partnership or sole proprietorship, an LLC is a more formal business structure.

Most people use the terms LLC and S corp interchangeably; however, they refer to two different aspects of the business. While an LLC is a legal business entity or legal entity, an S corporation is more of a tax classification.

When a business decides to elect S corporation status, it lets the Internal Revenue Service (IRS) know that the company must be taxed as a partnership.

To elect S corporation status, your company must register as a C Corporation first or an LLC and meet certain criteria set out by the Internal Revenue Service.

LLC vs. S corporation taxes

It is possible to form and operate your company as an LLC but still be taxed as an S corp. Ultimately, there are several differences when you’re considering forming an LLC as an S Corp. Let’s take a look at the differences between how an LLC and an S Corp pay taxes.

LLC taxes

  • The income and losses of an LLC pass through the business and are instead reported on the owner’s personal tax return. This is called pass-through taxation, so an LLC is a pass-through entity.
  • Therefore, the profits or income is taxed at the owner’s personal tax rate and not at the corporate level.
  • If only one member runs the LLC, it’s referred to as a single-member LLC, and the structure is taxed as a sole proprietorship. Therefore, all deductions, losses, and profits reduce the taxable income reported on the owner’s personal income tax return.
  • If the LLC has more than one owner, it’s referred to as a multi-member LLC, and each member reports losses and profits on their personal tax return.
  • LLCs also avoid the double taxation that C corporations are subjected to since they pass all profits or company income through to the personal income tax returns of the individual members.
  • LLCs are liable for self-employment taxes.

S corp taxes

  • Once you elect S corporation status, you can pass corporate income, deductions, losses, and credits to the corporation’s shareholders for federal tax purposes.
  • The shareholders report business income and losses on their personal tax returns. This is how S corporations avoid double taxation.
  • Double taxation is when the company’s income is taxed at the corporate level (called a corporate tax), and the shareholders are also taxed on their personal tax returns for their dividend income.
  • To file taxes, S corporations must use Form 1120S. This tax form reports S corporation shareholders’ losses, income, and dividends.

LLC vs. S corp: Formal requirements

LLCs and S corporations have formal requirements; however, they are different. Let’s have a look at them below:

Formal requirements for LLCs

  • Compared to other business entities or corporate structures, the business requirements are much simpler for LLCs.
  • LLCs are encouraged to follow the S corporation guidelines; however, they are not legally obligated to do so.
  • Some requirements or suggested requirements include conducting annual shareholder meetings and adopting bylaws. However, instead of the detailed requirements for corporations to create corporate bylaws, LLCs may simply adopt an LLC operating agreement.
  • The operating agreement contains terms and conditions and the roles and responsibilities of all members. The operating agreement is drawn up to accommodate the new business and accommodate future growth.
  • Unlike corporations, LLCs do not need to maintain records of company meetings.

Formal requirements for S corps

  • S corporations must file the Articles of Incorporation with the Secretary of State.
  • S corporations also need a separate bank account for the business and a registered agent, and a tax identification number.
  • An S corporation must also obtain the relevant licenses and permits to provide services in its selected industry.

Ongoing compliance

LLCs are responsible for paying the necessary annual filing fees, submitting the necessary reports, and renewing licenses and permits. On the other hand, S corporations are subject to more stringent ongoing requirements like keeping the bylaws up-to-date, recording minutes of meetings, holding annual shareholder meetings, paying state and federal taxes, and obtaining licenses and permits to remain in good standing.

LLC vs. S corp: Management structure

There are quite a few similarities and differences between the management structures for LLCs and S corps. So let’s take a look at that below:

LLC management structure

  • LLCs may choose to have the business managed by the members, or they may choose to hire an individual outside the company to run day-to-day operations.
  • LLCs need to nominate a registered agent responsible for accepting legal documentation and service of process on the company’s behalf.

S corp management structure

  • S corporations need to elect a Board of Directors who will be in charge of overseeing the operations of the corporation.
  • Aside from electing a Board of Directors, an S corporation will need officers and a registered agent to accept the service of process and legal documentation on the corporation’s behalf.

LLC vs. S corp: Owner structure

The ownership structure between LLCs and S corporations is significantly different. So let’s take a look at those key differences below:

LLC ownership

  • LLCs can have an unlimited number of members or owners. The owners of an LLC are also allowed to be non-US residents, non-US citizens, and U.S. citizens.
  • Any other type of corporation or entity type may own an LLC, and overall, LLCs face much less regulation in terms of how they are formed and ongoing maintenance.

S corporation ownership

  • The Internal Revenue Service restricts ownership of S corporations or who can be S corp owners. Therefore, S corporations cannot have more than 100 owners or shareholders.
  • They cannot be owned by any person who is not a U.S. citizen or permanent resident of the U.S.
  • Other types of corporate entities are not allowed to own S corporations. These restrictions include ownership by C corporations, other S corporations, business partnerships, LLCs, and sole proprietorships.

Summary

When deciding whether to form an LLC or S Corp, you need to consider all the factors mentioned above. The type of industry you’re in, the size of your company, and your business goals will also play an important role in your decision. An LLC could be a good choice if you’re planning on going with a single-owner structure with business management flexibility. In other words, an LLC structure is suitable if you want to have a simpler, smaller, and more personally managed company. However, an S corporation structure would be appropriate if your business is more complex.

FAQs

Whether or not you decide to incorporate as an LLC or S corporation will depend on several factors. However, one of the main differences between single-member LLCs and S corps is that with a single-member LLC, the company’s owner reports profits and losses on their personal taxes. However, with S corporations, all the shareholders can report profits and losses on their personal taxes.

While both business structures have advantages over each other, in terms of taxation, S corporations avoid double taxation. However, if you form an LLC and elect the S Corp. status, you can save money on taxes by allowing yourself to be taxed as a company employee.

One of the main disadvantages of forming an LLC is the high costs involved. Forming a partnership or sole proprietorship is significantly cheaper than forming a limited liability company. Initial formation fees, ongoing fees, franchise taxes, and annual report fees apply to LLCs.

Self-employed individuals are liable for self-employment taxes. Small business owners who don’t pay withholding taxes are also subject to self-employment tax. Self-employment taxes include Medicare and Social Security taxes that are reported to the IRS using Form 1040 Schedule S.E.

Yes, LLCs must nominate a registered agent, also known as a statutory or resident agent. This individual is responsible for accepting legal and official documentation from the state on your company’s behalf.

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]]> S Corp vs C Corp vs LLC: What’s the difference? https://www.chamberofcommerce.org/s-corp-vs-c-corp-vs-llc Mon, 09 Jan 2023 17:47:50 +0000 https://www.chamberofcommerce.org/?p=30485 One of the most important decisions you’ll need to make when starting a business is deciding on the entity type that will help you reach your business. Ultimately, your decision will depend on various factors such as control, taxation, liability, and the ease of raising capital. Every business structure comes with its own set of […]

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One of the most important decisions you’ll need to make when starting a business is deciding on the entity type that will help you reach your business. Ultimately, your decision will depend on various factors such as control, taxation, liability, and the ease of raising capital. Every business structure comes with its own set of advantages and disadvantages. The following guide will take a closer look at S corp vs. C corp vs. LLC.

Entity type
Liability
Taxation
Management
S corp
S corps offer personal liability protection, ensuring that the personal assets of owners cannot be taken to pay off business debts and obligations.
S corps are pass-through entities. So all income is passed through to the owners to report on their personal tax returns. There is no corporate tax paid by the S corps.
A board of directors and officers must be elected. They are responsible for managing day-to-day operations using the corporate bylaws as their guide.
C corp
C corps have limited liability protection, so personal assets are off limits in the event of business debts and lawsuits etc.
C corps experience double taxation. They are taxed at the corporate level and again on the individual level as shareholders must report income on their personal tax returns.
A board of directors and officers must be elected. They are responsible for managing day-to-day operations using the corporate bylaws as their guide.
LLC
Provides personal liability protection so that members are only responsible for debts, losses etc based on the financial investment they’ve put into the company.
Liable for income and self-employment taxes. Considered “disregarded entities,” income taxes are passed-through to members.
Must file Articles of Organization, relevant tax returns, annual reports and renew licenses and permits.

What is an S corp?

S corporations offer pass-through taxation, a huge benefit for small business entities looking to save on taxes. This is because S corporations are not liable for federal income tax, and the profits from the company are taxed at the individual level. Therefore, shareholders must meet certain criteria to ensure that corporate losses are offset by income from other sources.

Additionally, S corporations receive the same limited liability protection of default corporation status as a separate entity.

However, S corporations have limitations, such as the number of shareholders they can have, which may be a drawback for corporations that want to go public.

Additionally, ownership is limited mostly to individuals, and they must also be permanent residents of the United States or citizens of the US.

Alternatively, estate and tax-exempt organizations, as well as some domestic trusts, may also form S corporations.

S corp benefits

  • Protection of assets: A huge benefit of S corporations is the personal, limited liability protection that it affords owners. Therefore, owners’ personal assets are off-limits to creditors when paying off business debts and obligations.
  • Pass-through taxation: S corporations enjoy pass-through taxation, also known as flow-through taxation benefits. This means that the profits and losses of the corporation owners are to be reported on their individual tax returns. Therefore, the corporation is not taxed at the corporate level and avoids double taxation.
  • Dividend and salary payments: S corporations may receive both salary and dividend payments from the company, resulting in lower tax bills.
  • Ease of conversion: An S corporation may choose to elect a C corporation status at any point by simply contacting the IRS.

S corporation drawbacks

  • Membership limitations: One of the restrictions of S corporations is that they are not allowed to have more than 100 shareholders compared to other business structures, like C corporations that can have any number of members.
  • Allocation of profits and losses: When compared to how an LLC can allocate losses and profits, the requirements are far more stringent with S corporations. The profits and losses must be allocated among the shareholders and depend on the ownership percentage.
  • Corporation formalities: Corporations have strict formation and ongoing compliance requirements. The requirements are far more stringent when compared to forming a sole proprietorship, general partnership, and LLC.
  • S Corp status: To elect the S Corp status, you must meet certain requirements before being approved to operate and be taxed as an S corporation.
Check out our guide on How to Start an S Corp.

What is a C corp?

C corporations are the default corporation structure making it the most common corporate tax status. C corporations, like S corporations, also get their name from the subchapter of the IRC or Internal Revenue Code under which they are taxed.

Tax requirements are the differentiating factor between C corps and S corps. C corps are liable for corporate income tax with a federal return required by the IRS or Internal Revenue Service. After that, shareholders are liable for income tax on their share of the dividends. This is called double taxation since taxes are required on both the corporate and individual levels.

Unlike the S Corp, C Corp owners or shareholders cannot write off corporate losses to balance out other income on personal income statements.

However, one of the reasons C corps are desirable by many entrepreneurs is that there are no limitations on who can own shares.

Consequently, businesses within and outside the US can hold ownership of the C Corp.

Additionally, C corps do not limit the number of shareholders as S corporations do. All C Corp shareholders are also given full liability protections of any corporation.

C corporation benefits

  • Limited liability: When you form a C corporation, the IRS considers you a separate legal entity, meaning the business’s assets are distinct from yours. So your personal assets are off-limits in case lawsuits are brought against the corporation.
  • Better fringe benefits: C Corporation owners command more respect in B2B relationships with customers, clients, suppliers, and vendors. This is because C corporations signal that they are serious about their business since they have gone through the strict and detailed formation process.
  • Perpetual existence: The existence of your C corporation is completely independent of any board member, shareholder, or individual owner. In the event of any shareholder dying, the business itself will continue.
  • Tax advantages: One of the tax advantages that the C corporation enjoys is that shareholders may be given a salary even if they’re not involved in the day-to-day running of the business. The salaries are then claimed as business expenses which is a huge tax advantage in reducing corporate income tax.

C corporation drawbacks

  • Double taxation: Double taxation is the biggest disadvantage of forming a C corporation. Double taxation means the business is taxed at the corporate tax rate, and then the shareholders are taxed again at the individual level.
  • Complexity: A corporation is far more complex to run than an LLC in terms of operation and management structure. Certain formalities cannot be avoided if you want to have your company in good standing. Minutes of meetings must be recorded, annual shareholder meetings must be held, and proper notice must be given in terms of any changes in the company.
Read more about corporations.

What is a limited liability company (LLC)

A limited liability company LLC is considered a separate and legal business entity formed under state laws. A single business owner may form an LLC and, in this case, is considered a single-member LLC. However, if there is more than one member, it’s called a multi-member LLC. Multi-member LLCs also have the option to have the company managed by someone outside of the company or by the LLC members. Ultimately, the Internal Revenue Service considers LLCs separate legal entities from its members, and therefore they enjoy the same tax-paying benefits.

LLC benefits

  • Personal asset protection: LLCs appeal to entrepreneurs and small business owners since they provide personal asset protection. This means that if the company has any debts, obligations, or even losses brought against them, members’ personal assets cannot be used to pay off creditors.
  • Ownership flexibility: LLCs can be owned by individuals, corporations, partnerships, foreign entities, and trusts.
  • Credibility: LLCs have more credibility with financial institutions, vendors, clients, and suppliers since they are seen as more formal business structures when compared to general partnerships and sole proprietorships. 
  • Pass-through taxation: While LLCs are not the only business structure that enjoys pass-through taxation, it is one of the main benefits of forming an LLC.
  • Compliance requirements: LLCs have fewer compliance requirements when compared to business structures like corporations.
  • Management structure: LLCs have a lot of visibility regarding how the company is managed. For one, the LLC members do not need to hire a manager and can run the day-to-day operations between themselves. However, if the members have little time or the capacity to manage the business, an individual from outside the company may be hired to handle day-to-day operations.

LLC drawbacks

  • Transfer of ownership: All LLCs must create an operating agreement before beginning operations, as this will simplify and streamline a lot of processes that can become an issue later on. For example, LLCs can only bring on new members with all existing members agreeing. However, with an operating agreement in place, this issue can be avoided.
  • LLC costs: It costs far more to form an LLC than a sole proprietorship or a general partnership. Additionally, ongoing filing and annual fees are associated with limited liability companies.
Read more about LLC types here.

Should I start an S corp vs. C corp vs. LLC?

Deciding which business structure is right for you can be challenging if you don’t know the benefits and drawbacks of each entity type. C corporations are a popular corporation structure and come with their own set of advantages and advantages. The same can be said for all S corporations since they have tax advantages; however, they come with limitations in other areas. Limited liability companies as well offer business owners personal liability protection, but there are some drawbacks to this type of structure. So you need to look at several factors before making a well-informed decision.

S corp vs. C corp vs. LLC taxes

There are quite a few similarities and an equal amount of differences in how an S Corp, C Corp, and LLC are taxed. So let’s take a closer look at that below.

S corp taxes

  • For tax purposes, S corps are regarded as pass-through entities meaning that the shareholders or owners are responsible for reporting their share of the business’s losses and profits when submitting their personal tax returns.

C corp taxes

  • C corporations are subject to double taxation. This is because they are liable for both corporate income tax as well as personal income tax.
  • The corporation itself must submit a corporate income tax return, while the shareholders must also submit individual income tax returns on profits that they’ve received from the C corporation.
  • One of the only ways to not experience double taxation is to elect S corporation status.
  • Once you have S corporation status, you will avoid being taxed at the corporate level, as you’re only liable for personal income tax on the profits received by the S corp.

LLC taxes

  • LLCs are taxed differently from other types of entities. This is because the losses and profits from the company pass through to the business and are reported on the owner’s personal tax returns. This is considered pass-through taxation, and LLCs are considered pass-through entities.
  • LLCs’ profits or income are ultimately taxed at the personal tax rate and not at the corporate level.
  • If there’s more than one member in the LLC, it’s regarded as a multi-member LLC; therefore, each member in the company must report profits and losses on their personal tax return.
  • LLCs are liable for self-employment taxes.

S corp vs. C corp vs. LLC: Formal requirements

Different business structures have different formation requirements. So is the case with S corps, C corps, and LLCs.

Formal requirements for S corps

  • You need to elect S Corp status with S corporations by filing IRS Form 2553. Additional paperwork may be required depending on your state.
  • Additionally, S corporations need to file Articles of Incorporation or Articles of Organization, elect a Board of Directors and officers, appoint a registered agent, and create corporate bylaws.

Formal requirements for C corps

  • C corporations need to file Articles of Incorporation or Articles of Organization, elect a Board of Directors and officers, appoint a registered agent, create corporate bylaws, hold annual meetings, and record minutes of meetings.

Formal requirements for LLCs

  • LLCs are usually encouraged to follow the S corporation guidelines and are not obligated to do so from a legal standpoint. However, like corporations, LLCs must conduct annual shareholder meetings and adopt corporate bylaws.
  • Additionally, they need to compile an operating agreement laying out the terms and conditions and the roles and responsibilities of all LLC members.

Ongoing compliance

S corporations, C corporations, and LLCs also have ongoing compliance requirements that vary based on each state; however, they must be complied with to keep your business in good standing. Therefore, to remain compliant, you’ll need to adhere to the legal requirements of running your business, which include paying the relevant filing fees, submitting annual reports on time, and submitting Medicare and Social Security business taxes.

S corp vs. C corp vs. LLC: Management structure

Different business structures will have different management structures. Let’s have a closer look at them below:

S corp management

  • S corporations have a Board of Directors and officers in charge of running the day-to-day operations.

C corp management 

  • C corporations have a Board of Directors and officers in charge of running the day-to-day operations.

LLC management

  • With limited liability companies, they can hire a manager outside of the company or have the business members run the activities and operations.
  • In the case of LLCs, it’s important to have an operating agreement drawn up to ensure that all organization members are on the same page regarding how the business will be operated and managed.

S corp vs. C corp vs. LLC: Ownership structure

The ownership structure between S corps, C corps, and LLCs has differences. Let’s have a closer look at them below:

S corp ownership

  • S corporations are limited to the number of shareholders they can have, and the shareholders also need to be US citizens or any individual holding a US passport.
  • You can have up to 100 shareholders in an S corp.

C corp ownership

  • C corps do not come with any ownership limitations, and they can have an unlimited number of shareholders.

LLC ownership

  • LLCs have not been regulated in the same manner that corporations were.
  • The formal requirements and ongoing compliance and maintenance are much more lenient for LLCs than any other type of business structure.

Summary

When deciding on the best business entity type for you, there is no one-size-fits-all option. Therefore, your decision should be based on several factors, such as your business goals, tax benefits you’d like to enjoy, and the flexibility of ongoing maintenance and compliance. Before making the final decision, consider the fact that other business structures are out there. Some popular entity types are sole proprietorships, nonprofits, and partnerships.

FAQs

S corporations pay lower taxes than LLCs. This is because LLCs are liable for high self-employment taxes on the net earnings from the company, whereas when you elect S corp status, it allows you to pay only those taxes on the salary you take from your company.

The three main types of corporations include the C Corporation, the default corporation structure, and is subject to double taxation. The S corporation structure avoids double taxation and reduces self-employment taxes. The nonprofit corporation structure is formed for the greater good of society and is not intended to generate profits for owners or shareholders.

Forming an LLC comes with various advantages, including personal liability protection, flexible taxation, ownership, management flexibility, and relatively simple formation requirements.

One of the primary differences between a C corp and an LLC is that while LLCs are pass-through entities, they don’t file taxes on behalf of the business but report income on their personal tax returns. C corporations, on the other hand, are liable for corporate income tax; therefore, the corporation must file its tax returns.

Sole proprietors are not considered legal entities and have no existence apart from the owner called the sole proprietor. Therefore, sole proprietors must report all business income on their personal tax returns.

The post S Corp vs C Corp vs LLC: What’s the difference? first appeared on Chamber of Commerce.

]]> What is the Difference Between S Corps and C Corps? https://www.chamberofcommerce.org/difference-between-s-corps-and-c-corps Tue, 27 Dec 2022 11:50:47 +0000 https://www.chamberofcommerce.org/?p=29739 Both S corps and C corps have their similarities and differences. The main differences between a C corp and an S corp are how they are formed, the ownership restrictions, and how they pay taxes. The following guide will show you the advantages and disadvantages of each structure and help you make a well-informed decision. […]

The post What is the Difference Between S Corps and C Corps? first appeared on Chamber of Commerce.

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Both S corps and C corps have their similarities and differences. The main differences between a C corp and an S corp are how they are formed, the ownership restrictions, and how they pay taxes. The following guide will show you the advantages and disadvantages of each structure and help you make a well-informed decision.

Entity type
Liability
Taxation
Management
C corp
C corps have limited liability protection, so personal assets are off limits in the event of business debts and lawsuits etc.
C corps experience double taxation. They are taxed at the corporate level and again on the individual level as shareholders must report income on their personal tax returns.
A board of directors and officers must be elected. They are responsible for managing day-to-day operations using the corporate bylaws as their guide.
S corp
S corps offer personal liability protection, ensuring that the personal assets of owners cannot be taken to pay off business debts and obligations.
S corps are pass-through entities. So all income is passed through to the owners to report on their personal tax returns. There is no corporate tax paid by the S corps.
A board of directors and officers must be elected. They are responsible for managing day-to-day operations using the corporate bylaws as their guide.
LLC
Provides personal liability protection so that members are only responsible for debts, losses etc based on the financial investment they’ve put into the company.
Liable for income and self-employment taxes. Considered “disregarded entities,” income taxes are passed-through to members.
Must file Articles of Organization, relevant tax returns, annual reports and renew licences and permits.

What is a C corp?

A C Corp, also known as a C corporation, is a type of legal business entity owned by shareholders. The owners or shareholders then elect a Board of Directors, who, in turn, choose the officers to complete the management team. Some examples of C corporations are major corporations such as NASDAQ. However, corporations may also be small businesses.

A C corp is seen as a separate business entity by the Internal Revenue Service and pays taxes on its income.

Additionally, C corps are taxed on the personal level, so owners also pay personal income tax on profits or taxable income that they gain from dividends in the company. However, double taxation can be avoided by forming your company as a limited liability company or LLC or electing the S corporation status.

However, the latter business structures also come with their limitations. If you’re looking for limited liability protection for owners, then a C corporation offers it. Therefore, if the business goes into debt or is faced with a lawsuit, the owners are not held personally responsible, and none of their personal assets can be seized or used to pay off company debts.

However, a creditor can go pursue the business itself and the business’s assets; but none of the personal assets of the individual owners can be touched.

C corp benefits

  • Tax benefits: In a C corporation, shareholders may be given a salary even if they are not involved in running the company. The salaries may then be claimed as business expenses, delivering a huge tax benefit in reducing corporate income tax.
  • Perpetual existence: C corporations exist independently of any board member, owner, or shareholder. So if a shareholder or member passes away, the company itself will continue.
  • Fringe benefits: When it comes to B2B relationships with customers, suppliers, vendors, and clients, C corporations, command more respect. This is because they’ve gone through the strict process of forming the business and registering it with the state and federal government.
  • Limited liability: C corporation owners are considered separate legal entities by the Internal Revenue Service, which means that the company’s assets are distinct from the owners’ assets. Therefore, creditors cannot use business owners’ personal assets in the event of lawsuits, company debt, and business obligations.

C corporation drawbacks

  • Complexity: Corporations come with very strict formal requirements for creating the business and have stringent ongoing compliance requirements. The operation and management structure is also quite formal compared to sole proprietorships and partnerships.
  • Double taxation: The biggest drawback of the C corporation is the double taxation they are subject to. Double taxation simply means that the corporation is taxed at the corporate level, and the shareholders are then taxed again at the personal income level.
Read more about corporations.

What is an S corp?

An S corporation, also called an S Corp, is considered a separate legal entity by the Internal Revenue Service. It’s sometimes referred to as a small business corporation. It is a combination of the protection of an LLC and the corporate-level status of a C Corp. You can think of an S Corp as a hybrid between an LLC and a C Corp. Consequently, there are certain tax advantages to businesses that elect an S Corp status as an S corp is a tax status.

For one, an S corporation is not liable to pay federal income tax as its profits pass through to the business owners, who are liable for reporting them on their personal income tax returns. This is known as pass-through taxation. Therefore, S corporations do not pay double tax and are only taxed on the individual level. Additionally, S corps grant limited liability or personal liability to their owners.

S corp benefits

  • Pass-through taxation: One of the major benefits of S corporations is pass-through taxation, also referred to as flow-through taxation. Pass-through taxation is a term used to describe the profits and losses of the corporation passing through to the individual’s tax returns. Therefore, corporations do not pay corporate taxes but individual taxes.
  • Ease of conversion: If an S Corporation wants to change its structure to a C corporation, it can simply do so by contacting the Internal Revenue Service.
  • Personal asset protection: Another huge benefit of an S corporation is the liability protection provided to owners. In the event of any lawsuits, malpractice claims, or business debt being incurred, the owner’s assets cannot be used to pay off creditors.
  • Salary and dividend payments: S corporations may receive both the dividend and salary payments from the corporation, ultimately resulting in lower tax payments.

S corporation drawbacks

  • Membership restrictions: S corporations are not allowed to have more than 100 shareholders compared to C corporations, which can have unlimited shareholders. If an S corporation exceeds 100 shareholders, the owners will need to change the structure to a C corporation.
  • Allocation of profits and losses: Business entities like LLCs have flexibility when allocating profits and losses, whereas corporations must allocate profits and losses to shareholders based on the percentage of ownership.
  • S Corp status: S corporation status is not simply granted without meeting certain requirements and criteria. So to be taxed as an S Corp and be considered an S Corp, you will need to be approved and meet the necessary criteria.
  • Corporate formalities: S corporations, like C corporations, have stringent formation requirements compared to sole proprietorships, LLCs, and general partnerships.

At a glance: How is an S corp different from a C corp?

  • S corps and C corps have similarities and differences. One of the major differences is how they are formed and taxed and the restrictions on ownership.
  • C corporations must pay corporate tax rates on their corporate tax return, and there are no ownership limitations. However, when electing S Corp status, the structure is considered a pass-through entity responsible for reporting its income on the shareholders’ income taxes.
  • However, with S corps, the ownership is limited to 100 shareholders.
  • Ultimately, the decision will come with some implications in terms of your freedom to generate capital, how straightforwardly you can grow your company, and how you’ll pay taxes.

Should I start an S corp or a C corp?

To determine whether or not you need to remain with the default corporation structure, which is the C Corp entity, or whether you need to elect S corporation status, it all depends on the advantages and disadvantages that come along with both types of business entities. Therefore, you’ll need to consider quite a few factors, such as the number of shareholders you’d like to have in the corporation, the restrictions on ownership, the restrictions on classes of stock, the tax implications, and so on.

S corp vs. C corp taxes

There’s a difference between how S corps vs. C Corps are taxed. So let’s take a closer look at that below.

S corp taxes

  • An S Corp is considered a pass-through entity for tax purposes, meaning that the owners or shareholders must report their share of the business’s losses and profits on their tax returns.
  • Shareholders may report their share of profits and losses by filing Form 1120S.
  • S corp owners are liable for paying taxes at the personal income tax rate.
  • S corporations, along with other pass-through entities such as partnerships, sole proprietorships, and LLCs, may also be able to deduct up to 20% of qualified business income from their tax returns.

C corp taxes

  • C corporations experience something called double taxation. Double taxation is when the corporation pays taxes on the business profits as the corporate income tax return or Form 1120 is filed.
  • C corp owners are also liable for paying taxes on business profits on their personal or individual income tax returns. This is when the C Corp distributes these profits to owners as dividends.
  • You can prevent double taxation by electing S Corp status.
  • Alternatively, you can re-invest the profits into the company instead of paying them out as dividends. Some of the tax-deductible expenses include salaries, wages, and owners’ salaries.

S corp vs. C corp: Formal requirements

Although there are many similarities in how S Corps and C corps are formed, the differences begin with the formation process. Let’s take a closer look at it below:

Formal requirements for S corps

  • S corps must file the Articles of Organization, create corporate bylaws, elect a Board of Directors, and appoint a registered agent.
  • If you’d like to elect S Corp status for federal tax purposes, you must file IRS Form 2553.
  • However, depending on your state, you may need to file additional paperwork to be treated as an S corp.

Formal requirements for C corps

  • With a C corporation, you’ll need to file Articles of Incorporation, also referred to as Articles of Organization, and several other documents with the Secretary of State.
  • In this case, your corporation is the standard or default C Corp structure.

Ongoing compliance

However, you’ll still need to file the necessary paperwork and pay the relevant filing fees if you choose to structure your business as a C Corp or S corp. You are also responsible for remaining compliant by paying the relevant ongoing fees and submitting annual reports on time.

S corp vs. C corp: Management structure

  • A Board of Directors manages S corporations and C corporations and their officers. However, C and S corporations are responsible for remaining in good standing with the state by ensuring they file the relevant paperwork, send in the necessary annual reports and pay their taxes.

S corp vs. C corp: Ownership structure

The ownership structure for S corps and C corps are very similar; however, they have slight differences. Let’s take a look at them below:

S corp ownership

  • S corporations are only allowed to have a maximum of 100 shareholders.
  • To be a shareholder in an S corporation, you must be an American resident, a U.S. citizen, or a natural person holding a U.S. passport.
  • Entities like other corporations and trusts cannot own shares of stock in an S corporation.
  • Additionally, each shareholder has equal voting rights since only one class of stock is allowed for distribution.
  • It’s difficult to fund-raise as an S Corp instead of raising capital as a C corp.

C corp ownership

  • Preferred stock is an option that’s available only to C corps. A C corp will be an ideal choice if you’re planning on selling your company.
  • Another point to note is that a C Corp cannot own an S Corp, LLC, trust, or general partnership.
  • Other corporations, including trusts or LLCs, can own C corporations.
  • If you form the default corporation structure, which is the C corp, there are no limitations on ownership.
  • You can have an unlimited number of shareholders.
  • Additionally, you can also have various classes of shareholders.

Summary

There are differences between S corps vs. C Corps. However, there are advantages to each type of business structure as well. If you’re looking for options to expand and raise money, then a C Corp is your best bet. However, an S corporation is highly recommended if you’d like to save money on business taxes and be a small business owner. Before deciding which type of business to form, you should also consider other types of business entities and find out the advantages and drawbacks of each. Making the final decision to structure your business as a certain entity is quite a big decision with consequences and rewards for your business’s future. So take the time to consider all factors before making your final choice.

FAQs

When it comes to who pays more taxes between an S Corp and a C corp, the answer is C corps pay more taxes. This is because S corporations are not liable for double taxation like C corporations are. So C corporations pay income at the corporate and individual levels, while S corporations only pay income at the personal level.

While an LLC is a low-maintenance legal entity, if you do not elect a specific tax structure, then your LLC will default to be taxed as a sole proprietorship. However, LLCs can also choose to be taxed as S corps and enjoy single taxation or choose to be taxed as C corps and become liable for double taxation.

One of the major reasons to choose to form an S Corporation is the limited liability protection it offers regardless of tax status. The personal assets of the owners or members are shielded from creditors, and this is a huge advantage when it comes to business debt and litigation.

There is no specific S corporation tax rate since S corporations are not liable for federal corporate income taxes. However, this doesn’t mean that they are not liable for tax at the state level. However, in an S corporation, the corporation’s shareholders split up the incomes and losses between each other and then report them on their tax returns.

Forming an S corporation comes with several advantages, including protection of assets, pass-through taxation, straightforward transfer of ownership, heightened credibility, and the benefit of single taxation.

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]]> PLLC vs LLC: What’s the Difference? https://www.chamberofcommerce.org/pllc-vs-llc Mon, 26 Dec 2022 12:40:47 +0000 https://www.chamberofcommerce.org/?p=29662 Choosing the appropriate legal entity type for your business can be daunting unless you know the requirements and restrictions for each business structure. If the services you plan on offering require a certification or license, then a professional LLC, referred to as a professional limited liability company or PLLC, may be required by your state. […]

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Choosing the appropriate legal entity type for your business can be daunting unless you know the requirements and restrictions for each business structure. If the services you plan on offering require a certification or license, then a professional LLC, referred to as a professional limited liability company or PLLC, may be required by your state. If not, a limited liability company (LLC) may be the most suitable option for your business type. The following guide will help you understand the differences between PLLCs and LLCs.

Entity type
LIABILITY
TAXATION
MAINTENANCE
Professional limited liability company
Offers personal liability protection of professionals, so that personal assets are protected from the company’s debt, judgments and malpractice suits.
Taxed as sole proprietorships for single-member PLLCs and partnerships for multi-member PLLCs.
Must file relevant tax returns, annual reports and renew licenses and permits.
Limited liability company
Provides personal liability protection so that members are only responsible for debts, losses etc based on the financial investment they’ve put into the company.
Liable for income and self-employment taxes. Considered “disregarded entities,” income taxes are passed-through to members.
Must file Articles of Organization, relevant tax returns, annual reports and renew licenses and permits.
S corporation
S corps have limited liability and are protected from claims arising against the company.
S corps are pass-through entities, and they do not pay income tax at the corporate level.
Requirements for S corps are stricter, and they must have a board of directors, file annual reports, and tax returns and take minutes of all meetings held between owners.

What is an LLC?

An LLC is a limited liability company which is a type of business entity. LLCs can have one or more owners, also known as members. Ultimately, an LLC ensures its owners or members are not liable for the company’s financial debts and losses.

Limited liability companies combine aspects of corporations and partnerships. While they benefit from the limited liability status of corporations, they also enjoy the flexibility of pass-through taxation stemming from partnerships and sole proprietorships.

LLC benefits

  • More lenient compliance requirements: Forming and maintaining an LLC is much easier than other business structures like corporations. Additionally, you’ll have to adhere to fewer filings and ongoing compliance requirements when it comes to keeping the business in good standing.
  • Liability protection: One of the reasons for starting an LLC is the liability protection afforded to members. All this means is that in the event of a lawsuit or the business incurring debt or losses, members’ personal assets may not be used to pay creditors.
  • Membership flexibility: LLCs can be owned by trusts, partnerships, corporations, and individuals. Additionally, there’s no limitation or restriction on how many people can be members of the LLC.
  • Credibility with clients: An LLC is seen as more of a formal business entity and therefore has more credibility with suppliers, lenders, and clients than other business structures like a sole proprietorship or partnership.
  • Management structure: LLCs can be managed by the members. Alternatively, the members can nominate an individual from outside the business to manage the LLC’s daily operations.
  • Flow-through taxation: The income and expenses of an LLC are passed through to the members, who report them on their personal income tax returns. Therefore, LLCs are not subject to corporate taxes but individual taxes.

LLC drawbacks

  • Higher costs involved: It’s costlier to form and maintain an LLC than to form and maintain a sole proprietorship. Aside from the formation fees, ongoing filing fees, annual reporting fees, and taxes will need to be submitted.
  • Transfer of ownership: An operating agreement must be drawn up outlining what can and cannot be done within the LLC. This is because if you would like to bring on new members or change the percentage of ownership of current members, you’ll need the consent of all members before being allowed to do so unless the operating agreement specifically makes room for this.
Read more about LLC types.

What is a PLLC?

PLLC stands for professional limited liability company. It’s a business entity offering personal asset protection for business owners in licensed occupations such as law or medicine. However, you should note that PLLCs are only recognized in some states and are subject to the same rules and regulations as ordinary LLCs.

Additionally, in a PLLC, each owner’s professional license must be verified before the Articles of Organization are approved for the PLLC.

States like Arizona, Arkansas, Florida, Kentucky, Massachusetts, Mississippi, Pennsylvania, Utah, and Washington recognize PLLCs, while states like Alabama, Alaska, California, Nebraska, New Jersey, Wisconsin, and Indiana do not recognize PLLCs as legal business entities.

PLLC benefits

  • Compared to other business structures, PLLCs are far easier to form since they are more cost-effective and have fewer compliance requirements.
  • PLLCs also have the choice of being taxed as a corporation or a flow-through entity.
  • In the event of business debts and obligations, PLLC members are not held personally liable.
  • In the case of malpractice or negligence by another member of the PLLC, the other members cannot be held responsible, which is a huge advantage over sole proprietorships in general partnerships.

PLLC drawbacks

  • PLLC income is subject to self-employment taxes.
  • In many states, the eligibility to form a PLLC is limited to certain licensed professions.
  • PLLCs are not recognized as legal business entities in all states in the US.

At a glance: How is a PLLC different from an LLC?

  • Limited liability companies are recognized as legal business entities in more states than PLLCs.
  • In some states, professionals who want to provide services related to legal advice, medical care, accounting, tax services, and so on are required by state regulatory boards to form a professional limited liability company (PLLC).
  • Regarding malpractice claims against the company, PLLC owners are protected from personal liability for losses and business debts and are not liable for malpractice committed by their partners.
  • However, PLLC owners may be held liable for malpractice claims brought against them for their malpractice.
  • A few additional steps are involved in forming a PLLC compared to an LLC. The licenses of all professionals operating the PLLC need verification before the Articles of Organization are approved.
  • The Articles of Organization must be signed by a licensed member of the PLLC and will then be submitted to the licensing board before approval.

Should I start a PLLC or LLC?

The type of LLC you decide to form will depend on the services you plan to offer. Limited liability companies are a more flexible business structure requiring a minimum of one business owner or shareholder. PLLCs, on the other hand, are intended for licensed professionals wanting to offer types of professional services related to attorneys, veterinarians, accountants, physicians, chiropractors, dentists, architects, etc. However, as mentioned earlier, the requirements and restrictions associated with each entity type must be understood for you to make an informed decision.

Read more about PLLCs.

PLLC taxes vs. LLC taxes

When forming different types of business structures, you need to consider factors like ownership, management, and taxes. This is because how different business entities are taxed may differ from one entity type to the next or from one state to the next. Let’s take a closer look at how PLLCs vs. LLCs are taxed.

PLLC taxes

  • PLLCs are taxed by default as sole proprietorships if forming a single-member PLLC or partnership when it’s a multi-member PLLC. In this case, all the profits and losses of the business are passed through to the owner’s personal income tax returns. This is referred to as pass-through taxation.
  • Additionally, PLLCs are subject to Medicare and Social Security taxes. However, as with an LLC, PLLC members may choose to elect S corporation status. In this case, S corps are also treated as pass-through entities; however, Social Security and Medicare taxes are only incurred via their owner’s wages and salaries.
  • Therefore, owners are not subject to taxes on profits paid as profit distributions. Alternatively, PLLCs may be treated as C corporations for tax purposes if they find this structure more advantageous.

LLC taxes

  • LLCs are considered the same tax-paying entities as their owners or members, so income taxes are passed-through.
  • LLCs are not required to pay business income tax or file a business tax return. However, the profits and losses of the LLC must be reported by the members on their personal income tax returns, and taxes must be paid at the relevant individual tax rates.
  • LLC members do not receive paychecks, so they are also liable for Medicare and Social Security tax on their portion of the business’s profits.
  • If an LLC meets the Internal Revenue Service’s eligibility criteria, members may opt to be taxed as an S corporation. S corporations are also considered pass-through entities; however, members of an S corporation work in the company and go on the company payroll.
  • These members are only liable for Medicare and Social Security taxes on their salaries and wages from the company but not on income taken as distributions.

PLLC vs. LLC: Formal requirements

There are several differences between the formal requirements of PLLCs and LLCs. Let’s take a closer look at them below:

Formal requirements for PLLCs

  • If you choose to go with the PLLC entity type, then the process of PLLC formation may vary based on state law. This is why you must check with the Secretary of State’s office and your state licensing board to find out what forms or information must be filed.
  • To form a PLLC, your request for formation must be approved by the state’s licensing board by approving the PLLC’s Articles of Organization. This is one of the additional steps that the standard LLCs do not have to go through.
  • In most cases, when starting a PLLC, the state will check that every member is licensed in the profession and that at least one of those licensed professionals files the company’s Articles of Organization.
  • PLLCs must appoint registered agents, obtain EINs, and open a corporate bank account.
  • Banks usually require a personal guarantee when granting loans to PLLCs.
  • After formation, PLLC businesses fulfill compliance tasks such as filing tax returns, filing annual reports, renewing members’ professional licenses, renewing licenses and permits, and keeping business and personal accounts and transactions separate.

Formal requirements for LLCs

  • LLCs must file Articles of Organization with the state.
  • However, the advantage of LLCs over PLLCs is that the management structure is much more flexible. LLCs may also be managed by nonmember managers or members of the LLC itself.
  • LLCs also need to designate registered agents, get EINs, and open a business bank account.
  • They must also file the relevant tax returns and annual reports and renew licenses and permits.

Ongoing compliance

Your LLC is required to retain a registered agent, renew licenses and permits, submit annual reports, and file and pay taxes on time to remain in good standing with the state. Additionally, PLLCs are required to renew their professional licenses, renew other licenses and permits, retain a statutory agent, and file and pay taxes timeously.

PLLC vs. LLC: Management

In terms of management structure, PLLCs and LLCs are the same.

Both business entities are allowed to have a member-managed or non-member-managed company.

When members are permitted to conduct day-to-day business operations, it’s referred to as a member-managed structure.

However, appointing or hiring a manager from outside the company is referred to as a manager-managed structure.

PLLC vs. LLC: Ownership structure

While the ownership structure between PLLCs and LLCs are similar, there are a couple of differences:

PLLC ownership

  • Depending on the state of formation, the rules and requirements of PLLC formation may vary.
  • PLLCs may only be owned by the licensed professionals that will be offering the services that require the license. In some states, all members of the PLLC must obtain specific licenses for the services offered.
  • PLLC owners must have at least 50% professional ownership in some states.
  • PLLCs may encounter challenges due to members’ professional licensure if a member chooses to retire or leave. This means that if a member of a PLLC chooses to leave, members have to re-form or dissolve the company unless the operating agreement makes provision for perpetual existence in cases like these.

LLC ownership

  • Most states do not impose restrictions on who may start an LLC. Therefore, LLCs may be owned by corporations, foreign entities, individuals, trusts, and other LLCs.
  • There is also no limitation on the number of members involved in an LLC.
  • Certain states permit single-member LLCs which only have one owner.
  • LLC owners enjoy the privilege of protection from personal liability for any debts and obligations incurred in the company.
  • LLCs can continue or exist even if a member retires or leaves the limited liability company.

Summary

Once fully aware of what’s required and how you will be restricted with each business type, deciding to form a PLLC or start an LLC is easy.

The selected structure depends on the types of services offered and the state.

Each state has specific rules and regulations pertaining to both PLLCs, and LLCs, so ensure that you check with the relevant state agencies to make sure you know what’s required of you, irrespective of which business structure you choose.

FAQs

Suppose you’re thinking of forming a professional corporation. In that case, one of the standard rules is that every business owner should have a valid license to provide the services they are offering. So, for example, if you’re forming a law firm as a professional corporation, then each owner in the company must be a licensed attorney.

Members of a PLLC may be personally liable for any type of malpractice or negligence. This is why each professional in the PLLC must have malpractice insurance, which protects licensed professionals against patients or clients filing malpractice suits against them.

In states such as California, professionals are not allowed to form PLLCs or LLCs; however, they are allowed to form a professional corporation or limited liability partnership. This is because PLLCs are not generally recognized as legal entity structures in these states. Limited liability partnerships are another option available to businesses requiring licensed professionals.

Many small business owners find the LLC business structure quite appealing because it offers the same personal liability protection or limited liability protection as corporations but leaves out the strict formal requirements involved in creating and running a corporation.

Double taxation is when a company, such as a corporation, is taxed on the corporate level, and then the owners are taxed at the individual level. Pass-through taxation is when the profits and losses of the business are passed through to the owners to be reported on their personal income tax returns.

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]]> LLC vs Partnership: Which Should I Form? https://www.chamberofcommerce.org/llc-vs-partnership Mon, 26 Dec 2022 08:28:26 +0000 https://www.chamberofcommerce.org/?p=29542 When setting up a business structure, there are many things to consider, especially regarding the type of business structure you want to form. There are financial, administrative, and legal costs involved when deciding on any business entity type. If your business has at least two owners, you may set it up as either a limited […]

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When setting up a business structure, there are many things to consider, especially regarding the type of business structure you want to form. There are financial, administrative, and legal costs involved when deciding on any business entity type.

If your business has at least two owners, you may set it up as either a limited liability company (LLC) or a partnership. While both these business structures have similarities, they also have some differences in how they are operated and taxed and the type of liability protection afforded to owners.

The following guide will closely examine the differences between LLCs and partnerships.

Entity type
Liability
Taxation
Maintenance
Limited liability company
A pass-through tax structure combined with limited liability protection.
According to the IRS, LLCs may choose whether they want to be taxed as corporations or partnerships.
In terms of maintenance, an LLC is one of the easiest entity types to maintain due to the minimal amount of formal annual requirements.
Partnership
No liability protection as owners are not separate entities from the business.
Partnerships are taxed as pass-through entities.
Partnerships are just as easy to maintain as LLCs.
Corporation
Corporations are legal liability entities, so owners of the corporation are not liable for the obligations, debts, or losses brought against the business.
Corporations are subject to double taxation (on the corporate level and on the owners’ personal income) unless they elect S corp status.
Corporations need to hold directors’ and annual shareholders’ meetings, maintain detailed financial records, file a separate corporate income tax return, and fulfill a few more steps in order to remain in good standing.

What is an LLC?

LLC is an abbreviation for limited liability company. LLCs are considered legal entities. This is a type of business entity that offers personal liability or protection of personal assets for owners. If a lawsuit is brought against the limited liability company, members don’t have to use money out of their pockets to pay settlements.

Instead, LLCs are considered pass-through entities, and members can claim their losses and profits generated by the business on their personal tax returns. Therefore, LLCs are becoming increasingly popular among small business owners and entrepreneurs over the last decade. This is especially since an LLC only needs one person to operate.

LLC benefits

  • Tax benefits: The losses and profits of an LLC are passed through to the owners so they can report them on their personal income tax returns. Therefore, LLCs do not pay taxes at the corporate level.
  • Management flexibility: LLCs are quite flexible in how they can be managed. For one, the members of the LLC can choose to manage the business. Alternatively, they may nominate a manager from outside the business to take care of the day-to-day operations.
  • Credibility with lenders: An LLC has much more credibility with clients, suppliers, and lenders when compared to other types of business entities like partnerships or sole proprietorships.
  • Membership flexibility: Individuals, corporations, partnerships, and trusts are allowed to own LLCs, and there’s also no limitation on the number of owners an LLC may have.
  • Liability protection: If an LLC incurs debt or obligations or has a lawsuit filed against it, the owner’s personal assets cannot be used to pay off creditors.
  • Fewer compliance requirements: When forming and maintaining an LLC, far fewer compliance requirements and filings are needed compared to other types of businesses.

LLC drawbacks

  • High formation costs: LLCs require far more investment when forming and maintaining the business. Aside from the formation fees, limited liability companies must pay additional ongoing maintenance fees, which include annual reporting and franchise tax fees.
  • Transfer of ownership: All LLC owners must consent to onboard new members and any changes in the percentage of ownership of current members. The only way to avoid this is to draw up an operating agreement stating that all members’ prior consent is not needed for the tasks mentioned above.
Read more about LLC types.

What is a partnership?

Partnerships are formal arrangements or agreements between two or more individuals agreeing to operate a business and take shares in its profits. There are various types of partnership agreements, and in this type of business, the partners share liabilities and profits equally. Partnerships also tend to have “silent partners” who invest in the business but are not involved in the company’s day-to-day operations. For example, lawyers and doctors are often motivated to form limited liability partnerships.

Partnership benefits

  • More cash: Since a partnership may have two or more partners, there’s always the option of getting a new partner that can bring cash flow into the business. The individual might have strategic connections that the existing partners may be lacking or they might have the ability to raise more capital for the business and attract potential investors.
  • Sharing in the knowledge and experience of partners: New partners don’t just put in the cash flow; they also may have more experience and knowledge to complement your skills and ultimately help grow your business.
  • Additional business opportunities: Business partners share in all aspects of the business, including labor. Therefore, partners allow you to be more productive by giving you the flexibility and ease to pursue other business opportunities.
  • Savings: In terms of capital expenditures and expenses, a business partner allows you to share the financial burden instead of carrying all of the expenditure squarely on your shoulders.
  • Fresh perspective: It’s not uncommon to have blind spots in how we think and conduct business. However, having a new set of eyes can help you spot what you’ve missed.

Partnership drawbacks

  • Selling complications: You may decide to sell the business in the future; however, if all partners are not on board, it can be a challenge. This is why it is recommended that your partnership agreement includes an exit strategy.
  • Loss of autonomy: Running a sole proprietorship differs from running a partnership. This is because, in partnerships, you need to share control of the business with someone else; therefore, important decisions will need to be made jointly and not unilaterally.
  • Liability: Partnerships do not offer liability protection or protection of personal assets. Therefore, in the event of company debts, business obligations, or business losses incurred by other partners in the business, it will also affect your personal assets and finances.

At a glance: How is an LLC different from a partnership?

  • Limited liability companies (LLCs) are considered separate entities from their owners.
  • The partners can pay taxes as a C corporation or an S corporation.
  • LLCs also offer protection of personal assets or liability protection to owners meaning that members or owners will never be liable for the company’s debts or obligations of the company to the extent that they have to contribute out of their own pockets.
  • LLCs have unlimited lifespans; even if an owner decides to sell their share of the business interest or the owner passes away, the LLC can continue.
  • With partnerships, the business debts are the responsibility of every partner in the business.
  • Additionally, the business does not have any legal identity aside from the business partners or owners, who become co-owners in the partnership.
  • In the case of a business partnership, once a partner sells the ownership interest or dies, the partnership also ends.

Should I start an LLC or partnership?

When deciding which entity type you’re going to form, there are many factors to consider, such as the liability protection offered, tax benefits, etc. While LLCs have their advantages, so do partnerships. You need to carefully consider each entity’s maintenance requirements, management procedures, and ownership structure before deciding which is the right one for you.

Read more about partnerships here.

LLC taxes vs. partnership taxes

In most cases, different structures enjoy different benefits. This is also the case with LLCs and partnerships. So let’s take a closer look at LLC taxes vs. partnership taxes.

LLC taxes

  • LLCs are normally taxed as partnerships or sole proprietorships unless they file relevant forms from the IRS to elect to be taxed differently.
  • Income and expenses of the LLC pass through to the business and are submitted with the owner’s personal or individual tax return since an LLC is considered a pass-through entity.
  • The LLC owner is responsible for reporting their business deductions, profits, and losses to the Internal Revenue Service using a Schedule C Form.
  • Multiple owners must file the Schedule C Form and their tax returns.
  • Another option available to limited liability company owners is the preference to be taxed as an S corporation. In this case, you will need to complete and submit Form 2553.
  • After that, the Internal Revenue Service will tax your business as an S corporation for tax purposes, provided your application is approved. LLCs may also be required to pay self-employment taxes.

Partnership taxes

  • Partnerships are not responsible for paying corporate taxes. However, they are required to file a partnership tax return.
  • Additionally, partners are required to pay taxes based on their share of profits and losses. They may do so by filing a Schedule K-1 Form, and each partner is responsible for filing their form with their personal tax return.

LLC vs. partnership: Formal requirements

LLCs and partnerships both have varying formation requirements. So let’s take a closer look at that below:

Formal requirements for LLCs

  • When setting up an LLC, you must complete and file Articles of Organization and obtain a Certificate of Formation with the Secretary of State where you’re forming your LLC.
  • If you plan to conduct business in any state, your business must be registered with each state in which you plan to transact. Also, familiarize yourself with the various state laws to remain compliant.

Formal requirements for partnerships

  • Partnerships are created when two or more people form a business together.
  • These business types do not require any type of paperwork, and neither is there a need to file any documents with the local government to start operating legally in the state.
  • A partnership agreement is required to outline how the business will be operated and clarify all partners’ roles and responsibilities.

LLC vs. partnership: Management

LLCs and partnerships differ in the way in which they are managed. So let’s take a look at that below:

LLC management 

  • There are two types of management procedures involved in LLCs. The first is a manager-managed structure, and the next is a member-managed structure. In the manager-managed limited liability company, the owners of the LLC nominate a manager to handle the business’s daily business operations and administrative concerns.
  • In the member-managed structure, the owners all share the responsibility of managing the daily operations themselves.

Partnership management

  • In the case of a partnership, much of the management duties are shared equally between owners. This is why there’s something called a partnership agreement that outlines each partner’s share of ownership, authority, rights, and roles.
  • It’s also imperative to have a legal agreement in writing, even though it’s not compulsory. It simply ensures that all parties are on the same page, which will also help prevent future disputes.

LLC vs. partnership: Ownership structure

The ownership structure of an LLC is different from that of a partnership in certain ways:

LLC ownership 

  • LLC owners are referred to as members. There’s also a lot of flexibility regarding who can startup an LLC.
  • Even non-US residents in the United States are allowed to start LLCs.
  • Many states also allow groups, corporations, and other LLCs to form an LLC.
  • The minimum number of individuals to start an LLC is one.
  • However, there is no limit to the number of members an LLC can have; if more than one person is running the business, it may be considered a multi-member LLC.
  • LLCs tend to last indefinitely, so as long as an operating agreement outlines how the company will continue if members leave, pass on, or others vote to remove them, the business will still carry on as usual.

Partnership ownership

  • While general partnership owners have a general partner handle the business’s daily operations, limited partners are considered silent partners that may contribute to the finances. Still, they’re not involved in the running of the business.

Summary

Before deciding to start a company or partnership, each type of business has its benefits. However, before making your choice, you should always look at limited liability, income tax advantages, and ownership structure. Ultimately, whether you start a partnership or LLC will depend on your business goals, the size of your business, and the flexibility you’re looking for when running your business.

FAQs

Partnerships do not offer personal liability protection for owners. This means that all partners are personally liable for the business’s debts and the acts of employees and other partners. So you are severely and jointly liable for the company’s debts, and creditors can take action against you by using your personal assets to pay off the business’s debts.

In a partnership, the managing partner is tasked with overseeing the day-to-day operations of the business. This is why it is imperative to have a partnership agreement to specify and outline the responsibilities and duties of the managing partner.

If you’re forming a corporation, limited partnership, limited liability partnership, or limited liability limited partnership, you need to nominate a registered agent. However, sole proprietorships and general partnerships do not need to nominate one as they’re not registered with the state.

In the case of limited liability, the business owners are liable for the debt. However, this is limited to the investment they’ve put into the company. In the case of unlimited liability, the business owners are personally responsible for all or any loss, obligations, and debt that the company incurs.

While every state has its naming requirements and guidelines, the general rules encourage picking a name significantly different from any other registered business. You should also make your name web-friendly, consistent with your brand, and easy to remember.

The post LLC vs Partnership: Which Should I Form? first appeared on Chamber of Commerce.

]]> DBA vs LLC: What is the difference? https://www.chamberofcommerce.org/dba-vs-llc Mon, 26 Dec 2022 07:31:21 +0000 https://www.chamberofcommerce.org/?p=29460 If you’re planning on starting a new business, be it a large company or a new small business, you’re probably wondering whether you should form your company as a limited liability company (LLC) or “doing business as” (DBA). While a “doing business as” name and an LLC allows you to conduct business under your name, […]

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If you’re planning on starting a new business, be it a large company or a new small business, you’re probably wondering whether you should form your company as a limited liability company (LLC) or “doing business as” (DBA).

While a “doing business as” name and an LLC allows you to conduct business under your name, you must understand that a DBA is a registered nickname while an LLC is, in fact, a business structure.

The following guide will help you understand the differences between LLCs and DBAs to make a well-informed decision.

What is an LLC?

LLCs or limited liability companies are legal business structures. LLCs may be owned by a single person or more than one person. As the name suggests, owners of an LLC have limited liability protection which means that their personal assets cannot be used in any way to pay off the business’s debts.

The IRS considers LLCs separate legal entities from their owners, creating a financial barrier between them and the company. If you own an LLC, your personal assets can never be touched; however, creditors can go after the company’s assets.

To start an LLC, you must operate your business under the name of the LLC and open up a separate business bank account under your company name.

LLC benefits

  • Limited liability: When compared to sole proprietorships that are liable for their own debts and the company’s debts, LLCs are only responsible for their own debts and obligations. Their personal assets are shielded from creditors in case of a lawsuit against the company.
  • Tax benefits: LLCs can choose how they will be taxed, which is a huge advantage. LLCs may choose to be taxed as C corporations, S corporations, partnerships, or sole proprietorships. LLCs are pass-through entities meaning that the profits and losses are passed through to the members who report it on their individual tax returns.
  • Less paperwork: When compared to corporations, LLCs must submit much less paperwork to form the business. They don’t have to hold annual meetings, keep records of meetings, file annual reports, etc.
  • Management flexibility: LLCs don’t have to use a formal corporate structure. The owners have more choices on how the business is run when compared to corporations.
  • Ownership flexibility: LLCs enjoy pass-through taxation without any limitations on the number or type of owners they can have in the business.

LLC drawbacks

  • Self-employment taxes: LLCs are subject to Medicare and Social Security taxes, which corporations only pay on salaries and non-profits.
  • Fringe benefits: When LLC members receive medical reimbursement plans, group insurance, parking, and medical insurance, it is all regarded as taxable income.
  • Immediate recognition of profits: LLCs are not subject to double taxation; therefore, the LLC profits are automatically included in the members’ income to be taxed.
Read more about LLC types.

What is a DBA?

A DBA is short for or an acronym for “doing business as” name and is also known as an assumed name, trade name, or fictitious business name.

A DBA is not a business structure or entity type but a registration that you file with your city, county, state licensing agency or secretary of state to transact under that specific name.

If you own an LLC or corporation, you must register a DBA before conducting business under any other name than the name you listed on your formation or legal documents.

One of the purposes of the DBA is to let the public know who they are doing business with if there is an issue or if they need to bring a lawsuit against the company.

When you register a DBA, your business name will be in the government database and available for the public to access and find out that you are the business owner.

DBA benefits

  • Low cost: A DBA is an inexpensive way to set up a business name. It becomes the legal name of your business once it’s been registered with the county clerk.
  • Protection of privacy: DBAs are especially handy for sole proprietors and partnerships that want to keep their individual names private but still want to conduct business legally.
  • Versatility: Instead of establishing separate business entities whenever you have a business idea or want to branch out, you can simply register fictitious names or DBAs.
  • Flexibility: If the business name or legal entity name you’re considering is taken, a DBA name will allow you to expand into markets and other states where the desired legal name of your business is no longer available. 
  • Compliance: You can use the DBA name without incorporating it as an LLC or corporation when registering your DBA with the state.
  • Banking: When you set up a DBA, you can open up a business bank account in the DBA name.

DBA drawbacks 

  • No special tax benefits: Unlike when registering a legal business entity like a corporation or LLC, when you file a DBA, it doesn’t give you any special tax considerations. 
  • No trademark protection: Filing a DBA allows you to use that business name to conduct business. However, it doesn’t prevent other people from using the same name unless you register your business name as a trademark.
  • Maintenance woes: When you file a DBA, the registration must be maintained every few years. Some states even require that your DBA name be registered in every county where conducting business.
  • Geographical restrictions: If you want to do business in a different state, county, or city from where you registered your DBA, you’ll need to file your DBA in each of those regions before legally transacting. 

At a glance: How is a DBA different from an LLC?

  • Both LLCs and DBAs allow you to run your business under a different name; however, aside from that, there’s nothing similar about them.
  • LLCs limit your personal liability regarding business debts and obligations, while DBAs do not give you any type of personal liability protection.
  • It’s much more straightforward to set up a DBA than it is to set up an LLC. With a DBA, you simply need to pay a once-off registration fee, and there’s no need to complete or file any paperwork or comply with annual reporting requirements.
  • There are no exclusive rights to your business name with a DBA; however, forming an LLC does give you protection.
  • Whether you register an LLC or DBA, you need to get a federally registered trademark for the highest level of protection.

Should I register for a DBA?

A DBA can be helpful for many reasons. For one, it allows business owners to run their business under a different name without legally changing the company’s name.

If you’re already running an LLC but want to branch out of your current products and services under a different name, it’s a good solution.

If you’ve formed a partnership or sole proprietorship, you may not want to run your business under your personal name; in this case, a DBA is extremely helpful.

Unless you’re running a business under the official name, you will be required by law to register a DBA.

Read more about DBAs.

LLC vs. DBA

As mentioned earlier, there are quite a few benefits that the DBA and LLC offer. Let’s take a closer look at them below.

DBA taxes 

  • Your filing requirements and business taxes will remain the same after filing a DBA. So if you owned a sole proprietorship before filing your DBA or trade name, you’d continue to report your losses and income on your personal tax return.

LLC taxes

  • LLC tax considerations after filing include filings with the Internal Revenue Service [IRS] and the state tax agency.
  • Limited liability companies are considered pass-through entities by the IRS. This simply means that all business income is passed through to the members of the LLC to report on their personal income tax returns.
  • You’ll also have the option to elect S corporation status or corporate tax treatment.

DBA vs. LLC: Registration and maintenance

  • Both LLCs and DBAs are simple to register and renew. You’ll need to file the necessary documentation on the state level and pay the relevant filing fee.
  • To maintain the registration, your paperwork must be filed on an annual or biannual basis. However, the state fees and the application process vary from one state to the next for both DBAs and LLCs.
  • It costs far more to form an LLC than to file a DBA in nearly all cases. Registering a DBA doesn’t affect how you operate and run your day-to-day business activities. However, you’ll be able to do so under a different business name without risking your registration.
  • When you form an LLC, you must approach the company as a separate business entity, or you could lose your personal liability protection or limited liability.
  • You must separate your personal and business assets and create an LLC operating agreement to make sure that the roles and responsibilities of everyone involved are clearly outlined.

Trademark protection

  • Trademark protection is another option that you can use to keep other entities from using your business name to sell their goods and services. This is because a DBA filing does not offer trademark protection, which means anyone else can use your business name even if they are in the same city as your company.
  • However, registering an LLC can prevent someone in the same state from using a business name. To have your company name protected nationally, reach out to the United States Trademark and Patent Office or USPTO and register your business name.

Liability

  • LLCs offer Liability protection or legal protection, whereas DBAs do not.
  • Suppose a lawsuit is brought against a limited liability company. In that case, the owner’s personal assets, such as your home, car, or bank account, cannot be used to pay off the debts and obligations of the business.
  • However, when you file a DBA, there is no liability protection. If you don’t form a limited liability company or another business structure that offers limited liability, you will be responsible for business debts and obligations.

Summary

Whether or not to register a DBA after forming an LLC is entirely up to you. You’ll need to look at the advantages and drawbacks of doing so. In this case, a DBA offers several advantages and no drawbacks. So, in other words, an LLC will benefit from a DBA filing, especially when the company wants to branch out into new products and services. The DBA allows your limited liability company or your LLC to do so without creating a new business structure for each division.

FAQs

An LLC is a type of business structure that offers personal asset protection for owners, also referred to as members. However, DBAs are not business structures or types of business entities. Instead, they are a registration with one purpose: to allow your business to transact under a different name from its legal entity name.

When it comes to the costs involved in filing a DBA compared to filing an LLC, a DBA is cheaper. On the other hand, an LLC is a legal business entity requiring you to go through the formation process and file more paperwork with the state.

An advantage of a DBA name is that it allows you to conduct business under the DBA without having to create a separate legal entity if you want to branch out. However, one of the disadvantages of a DBA name is that there are no exclusive rights to it, and any other business entity can use your name even in the same state unless you registered it as a trademark.

Filing a DBA is to inform the public that a specific person or entity is conducting business under that name and that it’s not the legal entity name. This is for this reason; DBAs fall under consumer protection laws.

DBAs cannot be formed as they are not business structures. However, you can file a DBA by completing the relevant forms and paying the necessary filing fee. After that, you will receive a DBA certificate to transact under that name. Depending on the state you’re filing the DBA, you may need to file with your county clerk’s office, local office, or state agency.

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