Business Formation Consulting
Understanding and comparing incorporation versus an LLC is incredibly important when determining the right business structure to maximize the likelihood for success. Our firm can guide you through your incorporation or LLC formation, taking the time-consuming paperwork off your hands. We will discuss with you the advantages of incorporation, help you find and register a name, prepare and file your articles of organization, and provide you with a registered agent in Virginia. Although corporations and LLCs can both help protect personal assets from business debts and potential lawsuits or judgments made against a business entity, an LLC and an incorporated business offer a difference in benefits.
Limited Liability Corporation (LLC)
The limited liability company (LLC) is the most popular entity type for small businesses. An LLC combines the personal liability protections of a corporation with the tax flexibility of a partnership. The LLC offers many advantages, including:
- Pass-through taxation
- No residency requirement
- Enhanced credibility
- Legal protection
- Less paperwork than a corporation
When looking at business types, many business owners choose to Form an LLC. An LLC is a good way to “wall off” your personal assets from your company’s liabilities, offering protection for your personal assets in the event of a judgment against your business. For this reason, it’s a better fit for many owners than sole proprietorship or a general partnership.
An LLC also has certain tax advantages. The business itself is not responsible for taxes on its profits. Instead, the LLC’s owners, known as “members,” report their share of business profit and loss on their personal tax returns, similar to tax reporting for a general partnership. This is known as “pass-through” taxation.
The LLC Advantage:
- Pass-through taxes: Owners report their share of profit and loss on their individual tax returns.
- No residency requirement: Owners need not be U.S. citizens or permanent residents.
- Legal protection: Owners have limited liability for business debts and obligations.
- Enhanced credibility: Partners, suppliers and lenders may look more favorably on your business when you’ve formed an LLC.
C “General” Corporation
By forming a C Corporation, business owners create a separate legal structure that helps shield their personal assets from judgments against the company. C Corporations have a specific structure that includes shareholders, directors, and officers. The C Corporation is a time-tested business formation. It has many advantages, including:
- Limited liability for directors, officers, shareholders, and employees
- Perpetual existence, even if the owner leaves the company
- Enhanced credibility among suppliers and lenders
- Unlimited growth potential through the sale of stock
- No limit on the number of shareholders, although once the company has $10 million in assets and 500 shareholders, it is required to register with the SEC under the Securities Exchange Act of 1934
- Certain tax advantages, including tax-deductible business expenses
The C corporation is the most common type of corporation in the U.S. and has a number of advantages:
- Owners’ personal assets are separate from the company’s liabilities
- Unlimited growth potential through the sale of common stock
- Certain tax advantages, including reduced likelihood of an IRS audit, when compared to a sole proprietorship
The C Corporation structure does have its drawbacks. For instance, a C Corporation’s profits are taxed when earned and taxed again when distributed as shareholders’ dividends, what’s known as “double taxation.” Shareholders in a C Corporation also can’t deduct any corporate losses. To avoid these concerns, many small business owners choose to form an S Corporation instead.
If your corporation meets certain requirements, you can elect to claim an S corporation status with the IRS. An S corporation status allows your company to “pass through” its taxable income or losses to the business owners and investors, eliminating “double taxation” on shareholder dividends and corporate income.
S corporation status also offers limited liability, investment opportunities, continuous existence and a once-a-year tax-filing requirement.
Corporations that meet certain requirements can elect an S corporation status with the IRS. This federal tax status enables companies to “pass through” their taxable income or losses to owners/investors in the business, according to their ownership stake in the business.
By default, companies that do not specify a tax status with the IRS are considered to be C corporations – which means that they will be taxed as a C corporation.
On the other hand, by electing s corporation status, a corporation can eliminate the disadvantage of “double taxation” of corporate income and shareholder dividends associated with the c corporation tax status.
Example: (For the purpose of explanation only)
Say a corporation makes $300,000 in a given year – if it is an S corporation, the business itself will not be taxed for that amount; instead, the company’s shareholders will be required to pay taxes according to their share of the company. In this scenario, if the company has three shareholders, each with an equal share of company stock, each shareholder will pay taxes on $100,000.
If the C corporation makes $300,000 in a year, then the company would pay taxes at the current federal corporate tax rate of about 34%. If the remaining profits of $198,000 are distributed to the three shareholders as dividends, each shareholder will pay taxes on $66,000 in dividend income at the current federal dividend tax rate of 15%.
S corporations, like other types of corporate entities, also keep owners’ personal assets safe from company debt and judgments against the business.
Ownership of an S corporation:
- Is only available to persons who are U.S. citizens or naturalized, resident aliens.
- Other entities are not permitted to own shares of an S Corporation
- No Limit on the number of owners
- Profit and loss are passed through to the owners’ individual tax returns
- No annual meeting or minute book requirements
- May issue shares of stock to attract investors
- Corporate income splitting may help lower overall tax liability
- Cannot engage in corporate income splitting to lower tax liability
- Cannot issue stock
- Double taxation of corporate profits and shareholder dividends
- Must hold an annual meeting and record minutes
- S Corporations have restrictions on the number and types of owners