You want the best business entity for your business, right?
Congratulations! You’ve created a product or designed a service and are ready to launch your business. Most companies that are formed are classified as either a general partnership with multiple owners or a sole proprietorship with only one owner. While these structures are common they are often not the best option. This is because there is no distinction between you as the business owner and the business itself. Furthermore, if your business is sued or you find yourself unable to pay bills, you, as the owner, have to personally deal with the repercussions. In essence, you have no personal protection.
In order to protect yourself, different business structures should be looked at, namely a Limited Liability Company (LLC) and a Corporation or C Corporation. While each minimizes your personal liability, they have very different taxation approaches.
Here are five ways Limited Liability Company (LLC) and C Corporations differ so that you can decide which direction to choose.
Pass-through business structure vs. non-pass-through entity
There are no tax advantages – or disadvantages – to forming an LLC. Single-owner LLCs are taxed like sole proprietorships, and multiple-owner LLCs are taxed like partnerships.
Similar to a sole proprietorship is a pass-through entity, which is an LLC. Instead of paying income taxes on your business profits, you record your profits and losses on your personal tax returns. In essence, you pass through the numbers from your business to the owners.
A corporation, however, does not pass through anything because a tax return is filed for the business. The downside of this is that both the business and the owners, when they file their own tax returns that include their profits, are taxed. This is called “double taxation” and can end up being costly, especially to small business owners.
C-corporations are taxable business entities. For this reason, the corporation is taxed on its income. C-corps are favored by those who want to utilize a strategy called “income splitting.” Income splitting is to split the business income so that part of it is taxable tot he corporation and part of it is taxable to the corporation’s owner(s). The result is a lower tax bracket. A huge disadvantage of C-corporations is that distributions of profits (aka “dividends) are subject to double taxation. The C-corporation is taxed once on its income, then the shareholders are taxed upon dividends they have received.
Important note: An LLC can also choose to be taxed as a C or an S corporation.
Ability to leave money in the company
LLCs require members to pay taxes on all of their profits once they have been passed through, regardless if that money ends up being used for your business or not. C Corporations offer more flexibility in that as an owner you are only taxed on what you report as personal profit. For example, if your company has made $100,000 in profits for the year, you could leave $60,000 in the corporation as corporate profit and take $40,000 in salary.
Social security and Medicare taxes
Because they are not considered employees, LLC owners are not required to pay taxes for social security or medicare. Only members who are actively working in their business are required to pay taxes on their self-employment income. With C Corporations, Social Security and Medicare taxes are tied to salaries.
Ability to deduct a loss
When filing a personal income tax return, members of LLCs are able to deduct any operating losses their business may have incurred. Members of a C Corporation cannot deduct losses from income tax returns.
For some employee benefits like life insurance and health benefits, LLC members need to pay taxes. C Corporations, however, have the ability to offer stock options and some retirement plans.
Both LLC and C Corporation structures have different advantages, so it is important to understand the needs that you will have as a business owner, both now and in the future. Do your research, and if need be, talk to an expert to ensure that you know what makes the most financial sense to you. Make sure that your business works for you and not against you.
Latest posts by George Meszaros (see all)
- 9 Ways Outsourcing Can Help You Succeed in Business - February 15, 2018
- How To Prove That Your Startup Idea Is Right – Metrics That Matter - February 14, 2018
- 5 Steps to Select the Right Accounting Software - February 13, 2018