LLC vs Incorporations

Choosing Between the LLC and Incorporation

For many small business owners, a Limited Liability Company (LLC) offers advantages over a “C” corporation (also known as a “general” corporation). The LLC combines the tax advantages of a sole proprietorship or partnership with the liability protection of a corporation.

Pass-Through Taxation
The profits of a C corporation are taxed first at corporate tax rates. Then, if the C corporation pays dividends to shareholders, those dividends are taxed a second time at the personal income tax rates of the shareholders. This “double taxation” is avoided by the pass-through nature of LLC taxation. The Internal Revenue Service (IRS) does not consider an LLC itself to be a taxable entity. Instead, the company’s earnings “pass through” to the owners, who report their share of profits or losses on their individual tax returns. Only one personal tax return for each member is required, and the company’s earnings are taxed only once.

Special Allocations
In a C corporation, dividends to shareholders must be distributed in proportion to the number of shares they own. This is true regardless of the amount of effort an owner put into the business. In contrast, LLC owners can split profits or losses in any way they choose. Therefore, an LLC owner who owns 50% of the company may actually receive more or less than a 50% share of the profits or losses. This scenario, called a “special allocation,” must be accomplished in accordance with IRS regulations. Small business owners should consult their accountant or tax advisor for specific guidance regarding special allocations.
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