Should I form an LLC or corporation?

Knowing which business structure is right for you is not always a cut and dry decision, but why decide alone. Here we’ve outlined the advantages of an LLC vs Corporation to make the decision as seamless as possible. 

Most entrepreneurs and small business owners form LLCs rather than corporations. Why do you think that is? Well, for many small business owners LLCs are an attractive choice due to the tax advantages associated with LLCs and the pure simplicity of running and maintaining an LLC in comparison to a corporation. Yet forming a corporation has its own advantages. In this comparison we will look at when it’s best to form an LLC or a corporation. 

When to form an LLC

LLCs are usually the best business structure for small businesses mainly because it offers business owners limited liability protection. The limited liability protection an LLC affords business owners means that a business is considered a separate legal entity from business owners. This protects the seizure of their personal assets in the event the business is sued or found legally liable. LLCs are also extremely easy to run and maintain, and they afford business owners certain tax advantages that compliment how small businesses usually operate and grow.

Forming an LLC is the best decision if your business venture requires no financial assistance from outside investors, if you plan to invest most of the business’s annual profits back into the business and if an easy-to-maintain business structure suits your work ethic and personality better than say a more complex business structure like a corporation. 

In general, small businesses carry very little profits over to the following financial year because profits are usually spent on business expenses to spur on business growth, and the little profit a business does not reinvest, in other words the net income, is passed onto LLC members to be reported on their individual tax returns. This pass-through taxation principle is the tax advantage of forming an LLC. It means that the LLC will not be taxed at a corporate level as a business entity, instead LLC members are taxed on their individual share of the business’ net income. 

LLCs also require less official paperwork, they have less administrative overheads, and most importantly LLCs are adaptable and can therefore very easily be converted into a corporation at a later date.

When to form a corporation

If you are thinking about forming a corporation, the general rule of thumb says only small businesses that will need to rely on outside investors should form a corporation because only businesses who foresee the need to carry large amounts of profits from one year to the next will see the full extent of the tax advantages of forming a corporation. Small businesses will therefore only benefit from forming a corporation if there’s a need to attract venture capitalist and investors, if a business intends to carry over majority of its profits from one year to the next and if business owners foresee true benefits in managing such a complex business structure. 

Like LLCs, corporations also offer business owners limited liability protection, but unlike LLCs, corporations have complex operational procedures and tax advantages that are not always advantageous to small businesses. 

Corporations are not subject to pass-through taxation like LLCs are, instead they are subject to what’s called double taxation. This means a corporation’s net income is taxed twice, first on a corporate level and then again on an individual level on the dividends shareholders are entitled to. Shareholders pay income tax as well as FICA taxes on the dividends they receive. Once a corporation’s distributions are handed out, the corporation is only taxed 15% on all profits carried over to the next financial year, and surprisingly enough an LLC in the exact same scenario will have a higher tax burden. 

Concluding remarks

These are all things to think about when deciding between forming an LLC or a corporation, it’s about knowing the tax advantages and the complexity of the management structure of each.  Deciding which business structure is best for you depends on individual circumstance, and if your circumstances are similar to one of the two scenarios described above then you have your answer.