Structuring Your Business: Corporation vs. LLC

Corporations have some tax and operational benefits, but LLCs are much simpler to create and run.

Limited liability companies are a relatively new type of business entity that combine the personal liability protection of a corporation with the tax benefits and simplicity of a partnership. However, there are still other important differences. The following discusses the main advantages and disadvantages of corporations versus LLCs. 

Advantages of Corporations 

Profits are not subject to social security and medicare taxes. Like a sole proprietorship or a partnership, salaries and profits of an LLC are subject to self-employment taxes, currently equal to a combined 15.3%. With a corporation, only salaries, and not profits, are subject to such taxes 

Greater Acceptance. Since limited liability companies are still relatively new, not everyone is familiar with them. In some cases, banks or vendors may be reluctant to extend credit to limited liability companies. Moreover, there are restrictions as to the type of business that an LLC may conduct in some states. 

Greater variety of, and fewer taxes on, fringe benefits. Corporations offer a greater variety of fringe benefit plans than any other type of business entity. Various retirement, stock option and employee stock purchase plans are available only for corporations. Plus, while sole proprietors, partners and employees owning more than 2% of an S-corporation must pay taxes on fringe benefits (such as group-term life insurance, medical reimbursement plans, medical insurance premiums and parking), stockholder-employees of a C-corporation do not have to pay taxes on these benefits. 

Income Shifting. Although C-corporations are subject to double taxation, they also offer greater tax flexibility. In a C-corporation, you can use income shifting to take advantage of lower income tax brackets. 

To illustrate, let's take the example of a company that earns $100,000. With a sole proprietorship, a business owner who is married (filing jointly) would be in the 25% income tax bracket. With a corporation, assume that the business owner takes $50,000 in salary and leaves $50,000 in the corporation as a corporate profit. The federal corporate tax rate is 15% on the first $50,000. Furthermore, the business owner is now in the 15% tax bracket for his or her personal income tax. This can reduce your overall tax liability by over $8,000.  

Advantages of LLCs 

Fewer corporate formalities. Corporations must hold regular meetings of the board of directors and shareholders and keep written corporate minutes. Members and managers of an LLC need not hold regular meetings, which reduces complications and paperwork.

No ownership restrictions. S-corporations cannot have more than 100 stockholders, and each stockholder must be an individual who is a resident or citizen of the United States. Also, it is difficult to place shares of an S-corporation into a living trust. None of these restrictions or difficulties apply to an LLC (or a C-Corporation).

Ability to deduct operating losses. Members who are active participants in the business of an LLC are able to deduct operating losses of the LLC against their regular income to the extent permitted by law. Shareholders of an S-corporation are also able to deduct operating losses, but not shareholders of a C-corporation.

Tax flexibility. By default, LLCs are treated as a "pass-through" entity for tax purposes, much like a sole proprietorship or partnership. However, an LLC can also elect to be treated like a corporation for tax purposes, whether as a C-corporation or an S-corporation.

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