Which Should I Choose LLC vs. stance?

The sort of business an individual is starting, the potential tax repercussions of forming the firm, and other factors all factor into the choice to form an LLC or a corporation. Both forms of entities have the legal benefit of assisting in the safeguarding of assets from creditors as well as giving an additional layer of protection against legal liability.

Which Should I Choose LLC vs. stance?

An LLC is easier to form and operate than a corporation. Regardless, both forms of business models have advantages and downsides.

The Ease of Creating an LLC

Creating an LLC is far easier than forming a corporation, and it typically requires less paperwork. Because LLCs are governed by state law, the procedure for forming one varies depending on the state in which it is filed. Most states require you to file articles of incorporation with the Secretary of State, and some even allow you to do so online. A public notice, commonly published in local newspapers, is required in a few states. The LLC is formally constituted once these stages are accomplished.

Once an LLC is formed, it's a good idea to spell out the members' roles and obligations. Individuals that possess a piece of the LLC are called members. To specify these functions, most LLCs employ an operating agreement. It is not required to draft an operating agreement for an LLC to be valid, but it is a smart course of action. If an LLC does not have an operating agreement, it is controlled by state legislation's default norms.

The operating agreement outlines the members' rights and duties. It can describe the company connection and address concerns like capital structure, profit, and loss allocation, buyout provisions, provisions in the event of a member's death, and other significant business factors.

Tax Flexibility of an LLC

The Internal Revenue Service (IRS) does not view an LLC as a separate vehicle for tax purposes, which allows for greater flexibility. Members can choose how they are taxed. They can be treated as a sole proprietorship, a partnership, or a corporation. The most common tax option for an LLC is taxation similar to a sole proprietorship. A member has to pay taxes themselves on the profits of the LLC, as opposed to the LLC paying the taxes. The profits and losses of an LLC are passed through the business to the owner. The owner then has to report the profits or losses on their own personal tax returns. The LLC itself does not pay any corporate tax. This method avoids double taxation, which is a drawback of corporations.

Disadvantages of forming an LLC

Although an LLC does come with plenty of advantages, there are some disadvantages to consider. LLC members also have to pay a self-employment tax, which includes a 12.4% tax for Social Security and a 2.9% tax for Medicare.2

There are other drawbacks to an LLC as well. The purpose of an LLC is to protect its members from any liability. If the company fails to meet its obligations, only the LLC can be a target for creditors, not the assets of the members. However, there are certain situations in which an LLC can be automatically dissolved, leaving members open to risk.

Automatic dissolution can be triggered if an LLC fails to report its filings on time, death or withdrawal of any member occurs (unless succession provisions are outlined in the operating agreement), a change in the structure of the LLC, such as a merger, or any terms with expiration dates. In these situations, an LLC can continue doing business, but the liability structure of the members may be altered, defeating the initial purpose of creating the LLC.

Before the passing of the Tax Cuts and Jobs Act in 2017, an LLC treated as a partnership for tax purposes could automatically be terminated for tax reasons as well. The automatic termination was triggered if there was a transfer of 50% or more of an LLC’s total interest or profits within 12 months. This rule no longer applies to the tax year 2018 and beyond.

Another major disadvantage is the differences among states in the statutes that govern LLCs. This can lead to uncertainty for LLCs that operate in multiple states. The differences in rules and regulations can result in additional paperwork and inconsistent treatment across different jurisdictions.

Advantages of a Corporation

Despite the ease of administration of an LLC, there are significant advantages to using a corporate legal structure. Two types of corporations can be formed: an S corporation and a C corporation. An S corporation is a pass-through entity, like an LLC, where the owners are taxed on the profits and losses of the corporation.

A-C corporation is taxed at the corporate level, separately from its owners, through a corporate income tax. C corporations are the most common type of corporation.

TIPS Corporations have the advantage of allowing profits to remain with the corporation and paying them out as dividends to shareholders. Also, for businesses that eventually seek to issue stock, a C corporation can easily issue shares to raise capital for further expansion of the business.

Corporations offer more flexibility when it comes to their excess profits. Whereas all income in an LLC flows through to the members, an S corporation is allowed to pass income and losses to its shareholders, who report taxes on an individual tax return at ordinary levels. As such, an S corporation does not have to pay a corporate tax, thereby saving money, as corporate taxes are higher than ordinary taxes. Shareholders can also receive tax-free dividends if certain regulations are met.

Disadvantages of a Corporation

There are significant disadvantages to creating a corporation regarding the amount of complexity involved. It requires a great deal more paperwork, meeting many more guidelines, electing a board of directors, adopting bylaws, having annual meetings, and creating formal financial statements. They generally have more burdensome record-keeping requirements than LLCs.

There is also the issue of double taxation for corporations. This refers to taxes being paid twice on the same income. This is because corporations are considered separate legal entities from their shareholders. Thus, corporations pay taxes on their earnings while their shareholders also pay taxes on any dividends they receive from the corporation. 

The Bottom Line

Though similar in many ways, LLCs and corporations have quite a few distinctions that bring both advantages and disadvantages to each. As an individual starting their own business, it's important to understand all of the nuances involved and choose the right structure for your company.