There are two common types of businesses:
- "Pass-through" Businesses
Pass-through businesses are those in which the profits and losses of the business pass through to the owners or shareholders. In other words, the business income is considered as the owner's or shareholder's income, and the owner/shareholder pays the tax on his or her personal tax return.
- Separate Business Entities
Corporations are separate businesses entities. The profits and losses of the corporation are taxable to the corporation, not the owners (shareholders).
How are LLCs and Corporations Formed?
- Limited Liability Company (LLC)Set-up
An LLC is formed by one or more business people, as owners. The owners, called "Members," file Articles of Organization and set out an Operating Agreement. An LLC is a pass-through type of business, because the profits and losses are passed on to the Members depending on their share of membership.
- Starting a Corporation
A Corporation is a separate legal entity. It is formed by filing corporate organization forms in the state where the corporation is located, and by designating shareholders, each with a specific number of shares. The corporation also creates a Board of Directors to oversee the corporate business.
How are Corporations and Limited Liability Companies Alike?
Both corporations and LLCs limit the liability of the owners/shareholders from the debts of the business and against lawsuits against the business.
How are Corporations and Limited Liability Companies Different?
Corporations and LLCs are different in how they are taxed. Because corporations are separate entities, they are taxed at the corporate rate, while LLCs are taxed based on Adjusted Gross Income of the owners. Here is an example:
- A corporation has a profit of $350,000 for 2007. That profit is taxed at the corporate tax rate of 35 percent.
- An LLC has the same amount of profit of $350,000. Its two Members each have a 50 percent share in the LLC, so each one is taxed on $175,000 of income on his or her personal tax return. The income from the LLC is included in the 1040 on line 12, and is considered along with other income for that person or couple for that year.
LLCs may choose to be taxed as corporations, if this is advantageous to the company.