LLC or Corporation: Choosing the Best Fit for Your Business

Choosing between a Limited Liability Company (LLC) or Incorporation is crucial because it impacts your business operations, taxes, and funding. The structure you choose also determines the extent to which your personal assets are protected. Therefore, it’s important to pick one that offers the right balance of benefits and legal protection for you and your business.

Both LLCs and incorporations can shield your personal assets, but here are some key points to consider when deciding which one suits your business best:

When it comes to taxes, if your business is incorporated, your net income is taxed at the corporate rate of 21%. Additionally, your shareholders will need to pay Federal Insurance Contributions Act (FICA) taxes and income tax on dividends, a concept known as ‘double taxation’. Conversely, LLC investors pay taxes even if they don’t receive a distribution, while incorporation investors only pay taxes on received dividends.

If you plan on carrying profits into the next tax year, incorporation might be more beneficial since carried-over gains are taxed at about 21%. In contrast, LLC members have to pay state income taxes, federal income taxes, and FICA taxes, leading to potentially lower profits to carry forward. However, if you’re looking to grow your small business and pay profits to LLC owners, an LLC could be advantageous due to pass-through taxation, where owners pay taxes on the dividends and net income they receive, rather than the business.

Ownership is another important factor. In an LLC, ownership stakes can be distributed among members regardless of their financial contribution, offering more flexibility. The operating agreement details how membership interests can be transferred if a member leaves and allows trusts, other incorporations, and even foreign individuals to become LLC owners. This flexibility can be useful when involving new partners.

Incorporations, on the other hand, have shareholders who can buy and sell shares of stock, granting them rights like selling off stock or purchasing more to gain a larger business share. The business remains intact even if a shareholder exits.

Management structures also differ. Incorporations have a more rigid structure with officers managing daily operations and a board of directors overseeing business activities. Regular record-keeping and annual shareholder meetings are mandatory. LLCs offer more flexibility; owners can manage the business directly or appoint managers while avoiding formal roles like Vice President or CEO.

Annual filing requirements are less burdensome for LLCs, which don’t need to hold annual meetings or keep minutes of company meetings. In some states, annual reports aren’t even required, making it easier to operate flexibly, especially for startups. Incorporations, however, must hold annual meetings and maintain detailed records of shareholder discussions, including decisions on compensation, bonuses, and dividends.

Funding is also influenced by your business structure. LLCs may struggle to attract venture capitalists or secure bank financing because investors have to become LLC members first, giving them control over the company. This involvement can blur the lines of limited liability if personal loans are taken out. Incorporations are generally more attractive to investors due to the clear separation of management and ownership, easier access to equity investment, and availability of stock options.

If your business requires significant capital, incorporation may be the better choice as it’s easier to obtain bank financing. Investors prefer the financial rights they get with incorporations, where distributions are based on the percentage of shares owned. For example, a shareholder with 12% of the shares will receive $120 if the company declares a $1,000 dividend. In an LLC, distributions are based on the operating agreement, regardless of financial investment, and profit and loss allocations are also determined by this agreement.

For S corporations, income and loss allocation depend on percentage ownership, whereas C corporations don’t distribute profits, focusing instead on reinvesting earnings.

Overall, your choice between LLC and incorporation will depend on specific needs like tax preferences, ownership flexibility, management style, regulatory requirements, and funding necessities.