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LLC, Corporation, Sole Proprietorship? Which Is the Right Choice for Your Small Business

Corporation, limited liability company (LLC) OR sole proprietorship -- each of these structures offer your business different advantage and disadvantages. The following is a quick tutorial on these different business structures: 

What is a Sole Proprietorship?

If you own your business by yourself and have not registered as an LLC or a corporation, you are considered a sole proprietorship. 

The advantages of a sole proprietorship versus an LLC or a corporation:

  • You won't have to fill out any special paperwork or obtain any separate licenses to form a sole proprietorship.

  • You enjoy sole control of your business's profits

  • Under Virginia tax law, a sole proprietorship does not require a separate tax filing. In other words, your business income can be reported on your personal income tax form. A corporation, on the other hand, may be subject to double taxation. That means if your business is a corporation, it will be taxed on its profits. Then any dividends from the corporation's profits that are paid to you as a shareholder will be taxed again. 

The disadvantages of a sole proprietorship versus an LLC or a corporation:

  • If your business should go bankrupt or is sued, your personal assets, such as your car, home or savings accounts, will not be protected from creditors. Unfortunately, this means that you could potentially lose everything that you own. 

What is a Partnership?

A partnership is basically the same as a sole proprietorship, with the only difference being that it owned by two or more people, instead of by an individual. There are two types of partnerships -- limited partnerships (LP) and limited liability partnerships (LLP). In an LP, at least one owner is considered the "general" partner. This person is personally liable for any of the business's debts and has the responsibility for making decisions for the business. An LP also has a limited partner who has money invested in the business, but makes very few, if any of the company's business decisions and is not personally liable for its debts. In an LLP, all of the partners have limited personal liability for the business' debts, and no one is considered a general partner. 

What is an LLC?

LLC stands for limited liability company. If you choose to make your business an LLC, in most cases, you will not be personally responsible for its debts or lawsuits. In other words, a creditor who is owed money by your LLC cannot force you to sell your home to satisfy the business' debts. 

Advantages of an LLC versus a corporation: 

  • LLC's are relatively easy to form and require less paperwork than creating a corporation.

  • This business structure does not face double taxation.

  • LLCs are pass-through entities, meaning that the company's earnings and losses are reported on the personal income tax returns of its members and is not subject to corporate taxes.

  • If you are the sole owner, you will report your LLC's income and expenses on Schedule C of Form 1040. If there are two or more members, your LLC will be taxed as if it was a partnership. In some instances, an LLC may be taxed like a C corporation or an S corporation. Your tax professional can advise you on which would be best for your business. 

The disadvantages of an LLC versus a corporation:

  • LLC members are considered self-employed and, thus, must pay the appropriate taxes towards Medicare and Social Security

  • An LLC cannot go public.

  • An LLC may have to be dissolved if a member leaves or a new one joins the entity. 

  • Taxation can vary state to state for LLCs, so if you conduct business in several states, this structure may not be a good choice for you. 

What is a Corporation

Just like with an LLC, the owners of a corporation are protected from personal liability if their business should go bankrupt or is sued. If you decide to go the corporation route, you will need to pay the required fees and file articles of incorporation with the appropriate state agency.

You will have a choice between setting your business up as a C corporation or an S corporation. The owners of both types of corporations are known as shareholders, and they must elect directors from within their ranks. In a corporation, a business's profits are considered dividends, and these are distributed to each shareholder based upon the number of shares each owns. If you do not specify the type of corporation you want to create, your company will be considered a C corporation by default. 

S corporations have more restrictions than C corps.  For example, S corporations cannot have more than 100 shareholders and all shareholders must be U.S. citizens or residents. S corporations also cannot issue more than one class of stock. In addition, the shares cannot be owned by other companies, but, instead must be held by individuals, estates or by certain trusts. 

Advantages of a corporation versus an LLC? 

  • A corporation enjoys perpetual existence. That means if a shareholder should die or leave the company, the corporation can continue to exist. 

  • Corporations can issue shares. LLC's cannot. 

The disadvantages of a corporation versus an LLC

  • Double taxation (as described above)

Depending on which business structure you choose, there will also be different tax consequences. That is one reason why it is important that you speak with a CPA before deciding on a business type, especially since your decision could result in long-term tax impacts. Marek CPA & Associates offers a free initial consultations so we can fully understand the complexities of your individual tax situation.