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LLCs vs. Corporations

Both corporations and LLCs limit the liability of the investors (owners and shareholders) from the debts of the business and against lawsuits against the business.  It “limits” individual’s liability for actions of that business.  This is called the “corporate veil,” meaning that there is a separation between the liability of the business and the liability of the individual owners.

The concept of limited liability is usually expressed by stating that liability is limited to the extent of the person’s investment and/ or gains.

Both business types must  keep their finances separate from the activity of the owners to maintain their liability protection. If a court finds that the operations are not separate, the owners or shareholders can be personally liable for the actions or debts of the business

Single-Member LLC (One Owner)

An LLC is formed by one or more business people, as owners. The owner, called a “Member,” files Articles of Organization with the state. The Articles of Organization are like the “bones” of the LLC. 

An Operating Agreement is the “muscles and ligaments” of the business which details (i) managing the day-to-day activities  (ii) what happens if the Single Member dies, and (iii) establishes the Member’s ownership.

A single-member LLC  is unique because it has the same ownership type and liability protection as an LLC, but it’s taxed like a sole proprietorship.

A Single Member LLC is considered a disregarded entity for tax purposes.  This means that the business is disregarded as separate from the owner for most reasons, but the same as the owner when tax time comes around. The “disregarded entity” designation doesn’t affect the owner’s limited liability protection. At tax time, the Single LLC owner reports business income and deductions on Schedule C, like a sole proprietor.  

Multi-Member LLC (Multiple Owners)

An LLC is formed by one or more business people, as owners. The owners, called  Members,” file Articles of Organization with the state. The Articles of Organization are like the “bones” of the LLC. 

An Operating Agreement is the “muscles and ligaments” of the business which details (i) managing the day-to-day activities and (ii) each member’s percentage share of ownership.

An LLC is an entity separate from its owners. LLC members have an equity (ownership) interest in the assets of the business because they have made an investment of some kind to form or join the business.

An LLC gives owners liability protection, meaning they can’t be held personally responsible for debts or judgments against the LLC (so long as they follow certain formalities).

A multiple-member LLC pays taxes like a partnership. You can even have an LLC that’s taxed like a corporation or an S corporation. 

LLC Members are considered to be self-employed and they must pay self-employment taxes (Social Security and Medicare tax) on their share of the LLC’s profit each year.

Corporations

A corporation is formed (incorporated) by filing Articles of Incorporation in the state where the corporation is located– or where it wants to be located (often Delaware due to favorable laws).

The corporation also creates a Board of Directors to oversee the corporate business and the board agrees on bylaws (operating documents).

An incorporated business is separate from its owners. Corporate owners are shareholders or stockholders who have shares of stock in the business.

The corporation pays its own taxes, and the owners pay taxes on dividends as shareholders,  Since the business is separate from the owners, the owners have no personal liability. 

A corporation can be more complicated to start and maintain, but the current corporate tax rate of 21% may be an incentive to incorporate.  Similarly, certain types of businesses are more often organized as corporations to be more attractive to outside investors.

Corporate shareholders aren’t self-employed so they don’t have to pay this tax. Corporate owners who also work as employees have Social Security and Medicare tax taken from their paychecks. 

BONUS Option: An LLC Taxed like a Corporation

You may consider forming an LLC and then electing to have the LLC taxed as a corporation or S corporation.

To have your LLC taxed as a corporation or S corporation doesn’t change the way your LLC does business or how the company is organized as a legal entity; it just changes the way taxes are paid.

The S corporation is not formed separately; it’s a tax status. It combines the simplicity of the LLC with the tax benefits of a corporation. Your LLC can elect to be classified as a corporation by completing an election form, Form 2553, with the IRS.

Talk to your CPA to see if this makes sense for your business.

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