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 about this all the time, and you may be wondering what certain terms mean or if they apply to you. We can help!
In CSI Accounting & Payroll’s more than 50 years of working with small business owners like yourself, we’ve been asked plenty of times if a small business should be an LLC or a corporation. Here’s how we address these questions:
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What is a corporation? Should I be one?
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What is an LLC? Should I be one?
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What is the difference between a business entity and a legal formation?
What's a Corporation?
A Corporation is a type of business entity. There are three types of business entities: Corporations (C-Corps & S-Corps), Sole Proprietorships, and Partnerships. There are several differences and many pros and cons for each. 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. There's a more rigid structure for Corporations, and failure to follow their requirements will result in your corporate status being taken away.
To be an S-Corp, you need to have less than 100 shareholders (all U.S. citizens), and you can't be publicly traded on the stock exchange. Essentially, an S-Corp is the opposite of a Sole Proprietorship in that the business and individual taxes are separate. Learn more about what an S-Corp is.
What's an LLC?
Many people think LLC stands for “Limited Liability Corporation,” but that's incorrect. It stands for “Limited Liability Company” and is not a type of Corporation or entity at all; It's a legal formation.
An LLC legal formation is a legal shield to keep your personal assets away from a lawsuit if your business gets 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.
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
Business Entities vs. Legal Formations
Entities and legal formations are separate but associated with each other. 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 an entity and a legal formation, but you need to have a legal formation first to determine your business entity options.
At CSI, we offer a range of advice topics. When it comes to entities, we can advise on their unique tax benefits and consequences. However, since we’re not lawyers and cannot practice law, we won't advise on legalities behind the LLC legal structure. If you'd like to discuss legal structures, we can refer you to a qualified attorney!
Let's Find Your Ideal Business Entity!
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!
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