One of the major decisions to make before establishing any new successful small business is to decide whether to form a limited liability company (LLC) or a corporation. In the comparison of llc vs corporation, the primary considerations are how easy it is to start and maintain, the tax implications, and how much personal protection is granted to the owners or stakeholders.
Most small businesses, however, prefer forming an LLC seeing as it has unique tax benefits as well as being easy to maintain. Furthermore, it provides limited liability protection – this means that there is legal separation between the business entity and you. This way, your personal assets are protected if the business runs into any legal trouble.
Generally, small businesses who choose to form a corporation are ones who need external investors. Even though limited liability protection is provided, the operational procedures tend to be complicated and the business structure doesn’t offer particular tax advantages.
This is when it’s a good idea to form an LLC
As has been highlighted, the LLC formation is a good fit for your business if you don’t have a need for external investors, you intend to reinvest profit back into the business entity every year, you’d like a simple tax structure, or you would find it easy to maintain business structure advantageously.
Reinvest profit into the business every year
Small businesses tend not to carry over too much profit from one tax year into the next seeing as they spend a great deal of their profit on expenses related to expanding the business.
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This means that the net income of the business goes through to the individual tax returns of the LLC members. In essence, the gist of this is that the business entity technically won’t be subject to tax, but rather the members will have to pay income tax based on the business’s net income. This distribution portion is in accordance with income and FICA taxes.
On the other hand, a corporation’s net income will be taxed once at 21%. Should a part of that profit be distributed to shareholders, they will have to pay income tax as well as FICA taxes on that dividend.
LLCs are simple to maintain
LLCs don’t involve a lot of paperwork and they don’t require a lot of administrative overhead. Furthermore, LLCs are adaptable and should the circumstances of the business entity change then you can change to a corporation later on.
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As such, forming an LLC is a perfect solution in the beginning of a business.
When to tax your LLC as an S Corporation
It’s a good idea to tax your business as an S Corporation if the business makes enough profit that you can pay yourself a “reasonable salary,” it is projected that the business will product big dividends every year, the business has the ability to get to the break-even point between tax savings and payroll costs, and you don’t have to get external investors.
This is when it’s a good idea to form a corporation
There are times when it’s a good idea to start out your small business as a corporation rather than an LLC even though this is not as common as starting out as an LLC.
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However, the corporate structure is beneficial if you have to get venture capitalists and investors, you have to carry over a lot of profit from tax year to tax year, or a complicated business structure is more advantageous.
It is always important to consider the unique nature of your small business before choosing on the business structure. After you’ve ascertained what is important to you, as the business owner, and what is most necessary for your business entity then you can make an informed decision on the business structure and tax classification.
However, as has been noted, most businesses start out as LLCs. In this case, starting costs are only between $40 and $500 and the filing costs range in accordance with the state where the filing is taking place. There are also professional LLC formation services who do it all on your behalf – at a small price, however.