Registering your business as a Limited Liability Company (LLC) or Corporation (CORP) makes you a bona fide business owner in the eyes of the world, and legally you become officially legit.
This brings some important advantages. Imagine you create a successful business, but out of nowhere, despite your best efforts to prevent cyber security risks, you’re hit by a customer data hack that leads to legal fees. If you’re registered as either an LLC or incorporated, your personal assets will be protected against business liabilities.
This article will break down your business registration options, without the usual legal talk that gives most people a headache.
Before we dive deeper, here’s a short summary that clarifies the different types of businesses:
Now that we’ve clarified your two main options are business registration as an LLC or CORP, let’s look at which one would best suit your individual small business needs. Instead of long, boring paragraphs that are hard to digest, it’s easiest to break things down by what makes them distinct from each other:
First off, setting up either type of business formation, you’ll need to choose and register a business name, making sure it hasn’t been taken yet and that you don’t infringe on any trademarks.
An LLC is formed by one or more business owners, called members. You’ll file Articles of Organization in your state. The next step is to put together a contract called an Operating Agreement, explaining the management of day-to-day activities and defining each member's percentage of ownership.
Getting incorporated involves Directors, not Members. You’ll file Articles of Incorporation with the Secretary of State office (some states call these documents Certificates of Incorporation or Charter). The corporation must have a Board of Directors to oversee the corporate business, who write and agree on your Corporate Bylaws (operating documents). You’ll also need a business license and corporate bank account.
Learn more about the process: Steps to Start an LLC or Corporation.
LLC members are all owners (they have equity) who invested in the business. So they all share the assets, even if in different portions.
With a Corporate there are shareholders or stockholders. They own shares in the business, and are paid profits either in dividends or more shares.
Sole Proprietorships, Partnerships and LLCs are structured pass-through entities, meaning their profits and losses flow through to the individual owners. The owners pay their share of the company's profits on their personal income tax return (Form 1040 or 1040-SR), which keeps things simple.
With a CORP, profits and losses are held by the corporation as a business entity, entirely separate from the owners. So the corporation pays income taxes on its profits or losses. Some earnings are paid indirectly to owners as dividends, while some earnings are kept by the corporate entity.
One of the biggest differences between creating an LLC and CORP is how they’re taxed. Profits are called ‘net income’ for an LLC, and ‘net earnings’ for a corporation.
LLC owners get a distributed share of the profits annually, and pay taxes on it through their personal tax returns. That’s why it’s called ‘pass-through’ taxation. Any losses or operating costs of the business can be deducted from personal tax returns. LLC tax rates will depend on each owner’s total income, in the same way as a sole proprietor.
Because LLC owners are considered to be self-employed, you’ll be taxed accordingly (Social Security and Medicare). Some states also require an annual franchise tax, just for doing business in that state.
Corporations are a completely separate entity. Shareholders pay both corporate tax on their net earnings, and different tax on their dividends as personal income tax. Smaller corporations, consisting only of owners, have the option to pay themselves tax deductible salaries and bonuses, instead of dividends.
If you’re worried about potential double taxation as a corporation, there’s an upside to offset that. Large sums of money can be saved in the form of federal deductions, which are only available to corporations.
For example, a corporation can deduct all its business expenses, including operating costs, advertising, employee medical, and retirement plans.
The 2022 US corporate tax is 21% of profits. And if you think about it, this is lower than some of the individual tax rates. It’s also important to note that you only pay tax on the income your company retains at the end of the year — owners of a corporation can save on taxes by investing some profits back into the business.
As an LLC, or if your CORP has fewer than 100 shareholders (which means you can’t go public), the IRS gives you the option to file an ‘S-Corporation election’. This tax designation gives you ‘pass-through or flow-through’ taxation, where you pay taxes on all business profits through your personal tax return forms.
For LLCs, an S-Corp tax designation works well for added oversight if there are multiple people running the company, because you’ll need a Board of Directors.Plus the members can choose to be classed as employees to receive cash dividends from company profits.
Whereas CORPs get to bypass double taxation, because choosing the S-Corp designation makes you exempt from federal corporate income tax. To learn more, read S-Corporation Advantages & Disadvantages.
There is quite a lot of confusion around the word ‘incorporate’. Some resources use it when referring to both LLCs and CORPs. But although an LLC enjoys some of the benefits of a CORP, an LLC is not incorporated. Let’s summarize the differences:
Should you start an LLC or a Corporation? If you want a simpler business structure that combines pass-through taxation (simply paying your personal tax returns) with the limited liability of a corporation to protect your personal assets, then a Limited Liability Company is the way forward.
But if you’re looking to grow your business to have shareholders, pay dividends, raise capital, get federal tax breaks, and be taxed as a totally separate corporate entity, the solution is incorporation. It involves more formal responsibilities, but for many small businesses, the advantages are well worth it.
Learn more about the Steps to Start an LLC or Corporation.
The process for both LLC business registration and becoming incorporated can be complex for busy small business owners. That’s why you’ll want to simplify things, at an affordable cost — try RelateLegal, the only place where you can register your business name in seconds.
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