In the first entry of this two part blog series, we discussed four questions to ask yourself when deciding what business entity to choose. In part two, we go into detail about LLCs, Corporations, and tax considerations for each.
Limited Liability Company (LLC) or Corporation
The main reason to form an LLC or corporation is to limit your personal liability. In this form, the LLC or corporation owns the business and you own the LLC or corporation. As its own legal entity, the LLC or corporation creates a sort of artificial person. This means that an LLC or corporation effectively shields its owners from potential liabilities. Companies and corporations:
- May enter contracts
- Sue and be sued
- Are liable for their own debts and obligations
This legal separation limits shareholders or members from personal liability in many (but not all) circumstances. Both LLCs and corporations require registration, formal filings, and payment of fees to the state.
Aside from the standard LLC and Corporation entity forms, there are special entity forms that may be applicable to you. One such form is the Limited Liability Partnership (LLP), which provides the same tax advantages of an LLC. A significant difference between the LLC and the LLP is that the LLP must have at least one managing partner who bears liability for the actions of the partnership, where the LLC provides more liability protection.
The low-profit limited liability company, or L3C, is another form of entity. An L3C is a hybrid combination of an LLC and a non-profit, which operates to benefit the general public. The L3C does earn a profit, but only to help its cause to better social welfare in accordance with its mission.
Points to Consider
The determination between an LLC and a corporation falls on how you want to govern the entity and what tax advantages (or disadvantages) are important to you and your business. Governing an LLC is much less formal than overseeing a corporation. Corporations require either a Board of Directors or Shareholders to run the company. Boards of Directors typically require meetings, quorums, and other formalities. LLCs are exempt from those demands.
With regard to finances, LLCs have the ability to determine how financial interests are divided. If you want each member to have an equal share or have a disbursement that matches their capital contribution, either is possible with an LLC. A corporation, on the other hand, requires distributions to be made on each share. Corporations may offer numerous stock options and bonuses as incentives to employees and managers, which an LLC is unable to do.
On the topic of funding:
An important point to consider is that corporations can issue stock. This may make it easier for a corporation to attract investors and obtain funding than an LLC or partnership.
For tax purposes, a corporation may decide to be taxed as a C-corporation or an S-corporation. A C-corporation experiences double taxation. The corporation’s profits are taxed on the corporation’s tax returns, and any after-tax distributions to shareholders are taxed on the shareholders’ personal tax returns. Both S-corporations and LLCs are taxed as pass-through entities. Therefore, the profits and losses of the business are taxed on the personal tax returns of the members or shareholders. LLCs can elect to be taxed as a C-corporation, however, if that is more beneficial to the business.
If you’re ready to start your business, ask yourself these four questions and think about which type of business entity may be right for you. Next, schedule an appointment with an attorney at Rudman Winchell, where we will help you form your business.