Published Feb. 19, 2025 08:08PM EST
LLC v Corporation: Pros and Cons
When starting a business, most new business owners first have to decide in what form to create their business. The general rule of thumb is to create your business as a LLC. But it is worth discussing some of the advantages a corporation has. We outline some of those here, with a focus on the tax implications and practicalities.
Creating an LLC
An LLC is treated by the federal and state governments as a “pass through entity”. This means that neither government taxes the entity’s net income directly (though some states offer to do so for federal tax avoidance purposes, see our post here). Instead, for tax purposes, the net income of the entity is “passed through” to its owners. The owners then pay taxes on their share of the net income on their personal returns.
For example, if the LLC makes $100 of net income for a year and is owned 50/50 by two people, the LLC will not pay any taxes on that $100 of net income/profit. Instead, each owner will report $50 of income from the LLC on their respective personal income tax returns. They report this income and pay taxes on it regardless of whether the LLC has sent that $50 of profit to the owners. The $50 is taxed.
The benefit of that income being taxes is that when the LLC sends money to its owner, that transmission of money is not taxable. This is because the income was already taxed when the net income was taxed. In this way, the LLC avoids double taxation that occurs for corporations discussed below.
Other than this benefit, LLCs are generally more flexible entities that are easier to maintain. State law generally requires fewer corporate formalities than required for corporations. With the IRS, LLCs can also elect to be treated as a partnership, S-corporation, or C-corporation. So they can opt into all of the available tax regimes for entities.
Creating a Corporation
Corporations are not pass through entities. Governments will directly tax the net income of the corporation. For the federal government, that tax rate is 21 percent. And, unlike LLCs, Shareholders of the corporation do not pay taxes on the net income. But, also unlike LLCs, shareholders pay taxes on money sent to them by the corporation as dividends.
This creates double taxation: you pay 21 percent of the company’s net income, which leaves you with an amount of money available to be distributed as dividends. But when those dividends are paid, the owners then pay taxes again at their individual tax rates.
This double taxation is why most people avoid corporations. It is worth noting, however, that this is not an important factor if your plan is to reinvest any profits into the business. This would mean you do not plan to take money from the business for a while, such that double taxation is not a major factor.
Corporations also have the advantage of being seen as better vehicles for raising money from investors.
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Selecting the best entity for you is critical. It defines the taxation and general methods of operating for your business for years to come. Mid-Atlantic Law & Tax PLLC is here to help you think and talk through this decision. We will then manage the execution of the decision as quickly and efficiently as possible. Call us at 202-449-7888 or visit us here to schedule a consultation.
