When you own a small business, you want to make sure it’s structured and categorized correctly for legal and tax purposes. You probably hear suggestions for your business all the time from unreliable sources, and you may be picking up keywords and are unsure of what they mean or if they apply to you. This is especially true with business entity types and legal structures.
In CSI Accounting & Payroll’s more than 50 years of meeting with small business owners like yourself, we’ve been asked more than a handful of times if a small business should be an LLC or a corporation. Here’s how we address that question:
- What is a corporation?
- What is an LLC?
- What is the difference between a business entity and a legal formation?
What is a Corporation?
A corporation is a type of business entity. There are three types of business entities: corporations, sole proprietorships, and partnerships. There are several differences in these entity types, but a good summary in this instance is that corporations have separate business and individual finances, whereas sole proprietorships (an individual owner) and partnerships (multiple owners) have unlimited liability.
Since S-Corps are the most common type of corporation and apply mostly to small businesses like yours, we’ll touch on this type of corporation specifically.
In order to be an S-Corp, you need to have less than 100 shareholders, all shareholders must be U.S. citizens, and you cannot be publicly traded on the stock exchange. Essentially, an S-Corp is the opposite of a sole proprietorship in that the business’s taxes are separate from your personal taxes. It has its own unique opportunities and limitations which we wrote about in this article about what an S-Corp is.
What is an LLC?
Off the top of your head, do you know what “LLC” stands for? If you said “Limited Liability Corporation,” you’re incorrect.
“LLC” stands for “Limited Liability Company” and is not a type of corporation or business entity at all; it is a legal formation. This is where a lot of confusion lies.
An analogy that our accounting department manager likes to use is, “An LLC is an umbrella.” An LLC itself is not a taxable entity, but you can be one of four buckets underneath it:
- Sole proprietorship
- Partnership
- S-Corp
- C-Corp
The Difference Between a Business Entity and a Legal Formation
Entity types and legal formations are separate but associated with each other. In simple terms, a business entity is your defined relationship with the IRS and the federal government, and a legal formation is your defined relationship with your state. You’re required to determine both a business entity and a legal formation, but you need to have a legal formation first to determine your business entity options.
An LLC legal formation is a legal shield to keep your personal assets away from a lawsuit if your business were to be sued. Becoming an LLC is a way to “legally incorporate” a business without the entity type needing to be a corporation. Approximately 90% of our clients who register with the state of Minnesota do so as an LLC since it’s simple to do and costs a small fee. We advise following in their footsteps.
Meanwhile, corporations are types of business entities. There is a more rigid structure, and failure to follow the requirements for corporations will result in your corporate status being taken away. Of course, there are many different pros and cons for being any business entity.
At CSI, we offer a range of advice topics in our monthly meetings. When it comes to business entities, we can advise on their unique tax benefits and consequences. However, since we’re not lawyers and cannot practice law, we will not advise on legalities behind the LLC legal structure. If you would like to discuss legal structures, we can refer you to a qualified attorney!
Want to Discuss Your Ideal Business Entity Type?
With so many options to choose from, things can get confusing. Now that you’ve seen our breakdown of what corporations are, what LLCs are, and the differences between entity types and legal structures, you have a better understanding of if a corporation, LLC, or even both are good options for your business.
If you’re still wondering about business entities, CSI is ready to help — addressing the topic right in our initial strategy meeting. We know the ins and outs of them after over 50 years of working with small businesses.
Let’s have a conversation about your concerns with choosing an entity type when we connect in a free consultation. Just click the button below!
Otherwise, you can continue to read about:
