Are you wondering if it’s worth registering your business as an LLC? Let’s find out!
You probably know that when you incorporate a business, it’s been transitioned from a sole proprietorship or general partnership to a separate legal entity.
The LLC (Limited Liability Corporation) is the USA’s equivalent to a private limited company (LTD) – which is the common legal business entity in countries including the UK, Australia, Canada and Ireland.
In the USA, there are a couple of options for incorporation, namely LLC and Corporation.
So which legal structure should you choose?
This article looks at the core fundamental differences between an LLC and a Corporation and why the LLC is a good option for startup businesses.
LLC and Corporation
A Corporation is a single entity for both legal and tax obligations. For example, as a separate entity, it can sign contracts and take out loans. Plus, a Corporation can own assets.
However, the setup process is lengthy and involves setting up a board of directors, and there is a lot more compliance and administration.
The “corporation” offers a relatively predictable structure, perpetual life, and easy transferability of shares – essential features if you want to solicit outside investment.
An “LLC” (Limited Liability Corporation) is a legal business structure hybrid between a corporation and a sole proprietorship.
How? The LLC is similar to a corporation insofar as it protects the owners and shareholders from personal liability.
However, you get the best of both worlds with an LLC as it passes on the tax liability to the sole proprietorship (owner). How does this work? Well, there is a legal entity and a tax entity.
LLC Legal entity and Tax entity
The LLC is an independent legal entity, but for tax purposes, it is not recognized as independent insofar as the profits and losses of the company are reflected on the owners’ income tax returns.
The US Small Business Administration reports that small businesses are 99.9% of all US firms and employ 47.1% of all US workers.
5 Benefits of Registering as an LLC
LLCs provide some specific benefits to small business owners over corporations. Continue reading to know the advantages of registering your small business as an LLC.
1. Have Control
Individuals who are just starting their business on their own prefer to plan their courses.
Many states acknowledge a single owner of an LLC, so it means you can have complete control of your business if you are a self-starter. You can decide for your business independently without the need to seek advice or approval from partners or a board of directors.
Like a sole proprietor, you own, supervise, and operate your company without the same liabilities as a sole proprietor. You can have an operating contract to identify specific roles and responsibilities and form your business suitable for your needs.
2. Benefit from Limited Personal Liability
If your business structure is a sole proprietorship or partnership, you and your business are not separate entities. Therefore, the debts of your business are your debts as well. Moreover, your assets are at risk if your partner or employee are sued.
You have limited personal liability when you choose an LLC because the business is legally separated from you.
The firm is responsible for its obligations and debts. Even though you risk losing the money you invested in the company, your assets such as your house and bank account cannot be used to pay business debts. These assets are also protected if your employee, partner, or business is accused of negligence.
3. There Is Less Documentation
Although corporations also have limited liability, you need to complete certain documents that might not be great if you have a small business.
For instance, you typically have to attend yearly shareholder meetings, create annual reports, and pay fees to the state annually. You can also be required to do hefty recordkeeping.
However, owners are not required to submit reports or attend annual meetings in LLCs in most states.
4. Enjoy Tax Advantages
When it comes to tax, you enjoy the advantages of all the business structures. For example, LLCs do not have a federal tax category. However, they can follow the tax status of sole proprietorships, partnerships, and corporations.
The Internal Revenue Service or IRS designates them automatically as sole proprietorships or partnerships depending on the business’s number of owners. Therefore, LLCs can enjoy pass-through taxation all time.
Pass-through taxation means LLC owners do not need to pay LLC or corporate taxes. Instead, the income and expenses of the LLC go to the owner’s tax returns, and they use any profits to make personal income tax payments.
The distributions to shareholders on traditional C-corporations are taxed twice.
One is for the corporation, and the other one is for the owners. Even though getting taxed twice can be avoided and having pass-through taxation instead is possible with S-corporations, not all corporations are qualified.
5. More Flexibility in Management
As C Corporations give limited tax advantages, S corporations may be an option. However, there are many ownership restrictions in S-corporations, even if they have pass-through taxation.
For instance, having more than 100 shareholders is not allowed; they cannot have foreign shareholders, and corporations cannot be shareholders. However, aside from providing pass-through taxation, LLCs do not have any restrictions on how many and type of shareholders they are allowed to have.
Management flexibility is also enjoyed more in LLCs. A board of directors who check the company policies and officers who manage the daily operations is the fixed structure of corporations.
In addition, shareholders need to meet annually to elect board members and discuss other business-related matters. LLCs do not have this kind of management structure. Therefore, LLC owners have more options on how they operate and decide for the business.
In many cases, businesses divide their profits depending on the shareholder’s ownership interest or investment percentage.
For partnerships, owners generally divide the earnings equally. Depending on every stockholder’s distribution of ownership interest, corporations have the responsibility to make dividend payments.
LLCs members can keep the flexibility of profit allocation following the terms of the operating agreement of LLCs. However, they do have a proportion of ownership and the decision on how to distribute profits differently.
Moreover, special allocations, which the IRS creates, have a role in requiring allocations. This requirement does not depend on ownership interest. The allocation shows a legal economic situation rather than obtaining a tax advantage from the owners.
Start-up and small businesses are better suited to LLCs because it has a flexible and straightforward structure.
LLC owners can still enjoy having the control they’re used to when making decisions on how the business operates and grows.
The LLC offers the business owners limited liability and tax benefits. Plus, without the compliance and administration requirements of a Corporation, an LLC is not only easier to set up it’s less expensive to operate.
Larger businesses need the Corporation structure for legal and tax purposes, and ideally, your business will grow to eventually need this entity type.