Many executives may find themselves questioning if they made the right choice in incorporating their business. Doing so has certainly enabled them to procure limited liability at the expense of more forms and other obligations. They then choose between two options: a corporation or a limited liability corporation (LLC). Deciding which of these is better is subjective, and it would help to acknowledge a few points.
When Should You Choose an LLC?
LLCs being comparatively easier to form and manage make it a popular choice amongst local businesses. This is especially the case when the firm expects to own certain capital assets that may be worth more in the future. It is primarily because unlike corporations (often called C Corporations), LLCs and their owners do not have to remit tax on the rise in the value of the asset once it is sold.
When Should You Choose a Corporation?
Despite the factors laid out above, a corporation may still prevail as the better choice in several scenarios, such as:
- The firm is to have public investors: An LLC may be congruous when there are just a handful of investors. This may not hold up for many investors, especially when they start demanding corporate stock certificates that attest to their shares over the corporation. A lot of time could be saved in just forming a corporation in lieu of attempting to address this issue.
- The firm wants to provide specific privileges to managers: When a corporation is formed, managers may wish to hold shares as well as be employed there. For instance, they may be appointed as a CFO, entitled to remunerations and other privileges, such as complimentary insurance plans. These privileges shall be administered separately from regular income so that employees do not have to remit tax on them. As such, this is a favourable aspect to forming a corporation. However, only a fraction of health insurance remittances is disregarded for an LLC, leaving employees to pay tax on the remaining amount.
- The firm wishes to retain proficient personnel by awarding them stock: Unlike corporations, LLCs do not have stock. Employers may choose to offer their workers membership privileges, but the process is complex and simply not as appealing. Therefore, being engaged in a corporation would enable managers to retain their workforce by offering them worker stock benefits.
When Should You Choose an S Corporation?
A substantial benefit of this form of corporation is it does not entail self-employment taxes.
But what are self-employment taxes? Consider how taxes are not imposed on workers’ income. They are entitled to have at least 7.65% of it unscathed by tax for Social Security and Medicare Taxes. Additionally, 1.45% of the remaining amount contributes to Medicare Taxes. These are then sent to the IRS.
As a general rule, the tax percentage is 15.3%, with an extra 2.9% beyond this amount. The IRS imposes this very fraction on a self-employed individual’s income. This is all about self-employment tax.
The self-employment tax guidelines for an S Corporation are straightforward: S Corporation owners remit tax on the amount they receive as remuneration, not on the dividends. For instance, if the total amount is $50,000 and of this, the pay was $20,000, then the only taxable amount is 15.3% of $20,000.
On the other side of the spectrum, an LLC owner’s entire income is taxed, albeit the guidelines are unclear.
There are some yet to be approved propositions that would enable an LLC associate’s whole income to be taxed in the following circumstances:
- The associate partook in the business for over 500 hours during the relevant period
- The LLC operates in providing ministrations in certain spheres of work, including engineering and law
- The LLC associate reserves the right to approve agreements for the LLC
Till these propositions are approved, it should be maintained that the whole amount of an LLC member’s income is taxable.
Hence, an LLC associate may end up remitting higher tax amounts than an S corporation shareholder. It is essential to weigh up these pros and cons and determine if paying less tax is worth missing out on an LLC’s benefits.