Founding a company can be thrilling, exciting, and overwhelming at the same time. The small-business world is an exciting place to be, with fresh ideas and company strategies leading to unbounded innovation. Taking the proper steps to create a stable and viable young firm starts with many decisions. One is determining whether the organization is a “limited liability company” (LLC), “corporation,” or “doing business as” (DBA). Corporation is a common term, but what is an LLC? And what does DBA mean?
Taxation is the crux of the matter when it comes to how companies define themselves. Getting properly registered with the authorities is a critical early step. No business owner wants to find his or her new venture running afoul of the government, never mind at its moment of creation.
Fortunately, the U.S. Small Business Administration (SBA) and Internal Revenue Service (IRS) are clear about the meanings of the various terms they use. The following is a roundup of the practices associated with forming LLCs, corporations, and DBAs, as well as what these different terms mean.
What is an LLC? Limited liability company (LLC)
When a founder wants to create a corporate structure that will protect personal assets from financial liability due to business decisions, but doesn’t want to commit to the complexity of a full-scale corporation, the LLC is a valuable choice. The SBA notes that LLC foundation is slightly different depending on which state the new entity is created in, as each organization gains the protections granted to corporate shareholders without necessarily forming a full-scale independent body.
The SBA adds that there are several benefits to operating as an LLC, as well as a few drawbacks. Most prominent among the positives is that smaller LLCs that don’t rise to the corporation scale are easier and more affordable to establish and begin operating. With less paperwork to file with state authorities, it’s easy for a founder or partnership to initiate proceedings.
Once these partners have started their operations, they are free to distribute their profits in more flexible ways than under more developed corporate structures. Agreements among the company’s founders divide up the profits based on what they have put into the business, whether that is capital, time, or effort.
Of course, there are disadvantages as well. LLC members are self-employed according to tax law, so even though the LLC structure is not necessarily an independently taxable creation, the participants are subject to self-employment taxes that contribute to Medicare and Social Security.
There is also the chance that LLCs will dissolve if members leave, forcing the others to reset the structure of the business enterprise. The SBA notes that the operating agreement that announces the formation of an LLC can contain provisions for what to do when founders depart, but that the default in some states is dissolution.
The IRS offers a few more stipulations. For instance, financial businesses such as banks and insurers can’t be LLCs. The exact status of an LLC in the eyes of tax administration depends on how many people are involved — a one-person LLC is part of that individual’s taxes, and one with two-plus is a partnership or, if it files the extra paperwork, a corporation.
What Is a Corporation?
A C corporation, or simply a corporation, is its own entity for purposes of taxation. In comparison with the question of what is an LLC, a corporation is an independent business with shareholders who enjoy the same level of liability protection as the members of an LLC. The SBA notes that the expanded level of complexity associated with a corporation is both the attraction and drawback of forming such a business. On the positive side, a corporation is free to grow and become established. On the negative, it’s more expensive and time-consuming to take this kind of leap into the world of business ownership.
As with an LLC, corporations are registered with the states they are founded in, as opposed to the federal government in general. This means there is room for variation in the laws surrounding foundation. Individuals going through the steps of creation have to ensure they are in line with their states’ agencies. For example, some states may require the immediate issuing of stock certificates to the organization’s shareholders.
A corporation, unlike an LLC, is its own entity, which can be taxed and is held liable for its own debts. Founders who hope to go public, selling shares in their companies to investors at large, have to go with the corporate structure to do so. The corporation designation, with its greater commitment and potential for growth and investment, has its own set of positives and negatives noted by the SBA, which make an interesting contrast with the traits of an LLC.
The benefits of being a corporation include an appeal to potential employees. A corporation has the ability to offer benefits that smaller entities cannot, as well as the potential use of stock to attract high-quality hires. Stock is also central in capital generation by a corporation. Selling shares in the organization is a direct infusion of cash that can keep the business strong and growing.
Inevitably, taxation is another major issue for corporations. Corporate founders may find that the tax rate that applies to these companies is much lower than it would be if they were paying personal income tax on everything the firm makes — the setup that a non-corporate LLC could face. Of course, corporate founders do have to pay income tax on the money they receive from their work with the business but not the rest.
The “corporation” designation isn’t always the right choice for a small business. The disadvantages include the fact that it takes major investments of time and money to get this kind of company off the ground. The fees for running such a complex business are greater than those attached to an LLC, so leaders have to think carefully before incorporating. This entails extra records to keep and papers to file. Furthermore, the potential for taxation when the firm earns its profits and then when the money goes to shareholders is something to keep in mind as well.
The IRS notes a few details of a corporations’ operations in the tax realm, specifying that the same rules that protect shareholders from liability also stop them from taking a deduction when their corporations lose money. On the other hand, there are possible deductions available to corporations beyond those that apply to sole-proprietor LLCs.
What Is a DBA?
Associated with both of the aforementioned company types is “doing business as” (DBA). This is the name an organization trades under. Rather than a separate kind of business, the DBA moniker allows an LLC or corporation to operate under a name other than what it was founded as. The SBA notes that any name other than the legal name a founder registered a business under is a DBA, which needs to be cleared with the authorities. It should be noted, however, state authorities handle this process, which isn’t a requirement in all states.
Founding a company means assigning it a legal name, which begins as the name of the founder. The SBA specifies that anything else the company calls itself is a DBA, even if the founder’s name is in the title. The process of creating a DBA is handled by the regional government — county or state, depending on location. The process of submission has to occur when beginning a new firm or anytime an organization renames itself.
As opposed to the above definitions, a DBA does not have any tax or operational baggage. It is a moniker that isn’t a founder’s personal name. Just about every company that actively does business has one, whether it’s an LLC or a C corporation.
While the LLC and other business enterprises are contingent upon financial capacity, the sole proprietorship represents the grassroots effort of American capitalism. A sole proprietorship is the legal apparatus that helps to empower entrepreneurs — primarily within the middle class — who helped to create 4.7 million jobs in the decade preceding 2020.
When an individual chooses to start their own business, there are many tax incentives that can assist in their business development. The SBA offers many loans that can help entrepreneurs achieve their goals.
Business taxes, employee ID numbers, Social Security, Medicare, and other withholding considerations are important factors for small business owners to keep in mind.
Maryville at your side
Maryville University’s online Master of Business Administration program can offer budding entrepreneurs the skills needed to take the appropriate steps in starting a business. Visit Maryville online to learn more.