If you’re starting a new business, one of the first decisions you’ll make is what type of entity you want to form. Most entrepreneurs will either form a corporation or a Limited Liability Company (LLC). Choosing between the two is an important step in forming a business structure. But regardless of which one you choose, both entities can offer a number of benefits to your business. Not only will it allow you to establish credibility in your industry, but it will also give you limited liability protection.
The Definition of Limited Liability Protection
The term “limited liability” refers to a type of protection for your personal assets. It makes sure that your personal liability for any business debts and obligations is no more than the amount of money that you invested into the business. It will protect your home, automobiles, and other personal assets from being used to pay off any debts that were accrued by your business. Without limited liability protection, your home could be used as collateral for repaying business debt after a lawsuit or bankruptcy.
The Differences Between an LLC and a Corporation
A limited liability company combines limited liability protection with what’s referred to as a “pass-through tax structure.” The IRS allows LLCs to choose between being taxed as a partnership or a corporation. Because it has the fewest annual requirements, it’s the easiest entity to maintain.
With a corporation, the owners or shareholders have limited personal liability protection for any business-related debt. Unlike sole proprietorships, partnerships, and LLCs, corporations pay income tax on their profits.In some cases, they’re taxed twice (when the company makes a profit and when dividends are paid to shareholders).
Corporations have an independent life that’s separate from their shareholders. So if that person leaves the company or sells his or her shares, the corporation can keep doing business without interruption. When it comes to raising capital, corporations have an advantage over LLCs because they can earn money through the sale of stock (which can also be beneficial for attracting employees).
Tax Differences Between an LLC and a Corporation
One of the biggest differences between an LLC and a corporation is in how they’re taxed. An LLC is taxed as a “pass-through” entity, so the profits of the business are passed through to the owners (often referred to as “members”). Profits and losses are reported on each owner’s individual tax return rather than on the business itself. This simplifies the taxation process for LLC owners.
Corporations are taxed as separate legal entities, which can earn their own income. They’re also responsible for paying tax on their profits (referred to as “corporate tax”) and on dividends that are distributed to their shareholders. Unlike salaries and bonuses, dividends aren’t tax-deductible. So, they’re taxed twice (often called “double taxation”). This won’t be an issue for smaller corporations where only the owners work for the company. In these situations, the owners will receive tax-deductible salaries and bonuses.
Which Entity is Better for Small Businesses
Choosing whether to form an LLC or a corporation will depend on a business’s needs and goals. In most cases, LLCs are easier to set up and maintain (which makes them an ideal choice for small businesses that want more flexibility and lower compliance costs). LLCs can also help you avoid double taxation, which is possible with some types of corporations. Corporations may be more suitable for small businesses that plan to grow significantly or seek outside investors.
Converting an LLC to a Corporation
Converting an LLC to a corporation can come with a number of advantages, especially if you want to attract investors for the purpose of expanding your business. Corporations are structured in a way that makes it easier for them to raise capital through stock sales, which is a big advantage for businesses that want to grow more quickly or bring in more owners. Certain types of corporations can also have tax advantages.
Corporations have a more formal structure with more clearly defined goals, which is what some industries and investors prefer. But converting your LLC into a corporation can come with more regulatory requirements. Not to mention, the possibility of double taxation. That’s why you need to think about whether it aligns with your company’s goals before you make the change.
If you’re looking for a qualified attorney who can help you with business formation in Texas, be sure to get in touch with Gale Law Group. We have a team of experienced professionals who would be happy to speak with you!