So, your business is growing and you’ve decided you need to put some financial protections in place to help keep your company safe and to minimize your own personal risk of financial liability. It’s time to incorporate.
Now you have a choice to make that could have lasting ramifications for the future of your business. Which entity is right for you?
The two main entity options available to you are the Limited Liability Company (LLC) and some form of a Corporation. Both are legal designations that will help to protect your personal liability and add credibility to your company, so why would someone choose one over the other?
There are several key differing aspects you need to consider when choosing whether to incorporate as an LLC or a corporation including things like taxes, regulations, and structure. Below we’ve listed some of the advantages LLCs have over corporations.
- Ownership – A flexible ownership structure is one of the main reasons someone might choose an LLC over a corporation. There are generally less restrictions on who can start and manage an LLC compared to a corporation, and owners can build their management structure as they please without being hampered by regulations.
- Taxes – Potential tax benefits are another reason someone might choose an LLC designation over a corporation—in this case, a C-Corp. Generally, LLCs do not have to pay corporate taxes, and the profits and losses of the company can “pass through” to the owner’s personal income taxes. Corporations, on the other hand, are considered separate legal entities and are taxed individually, which can lead to a business owner being taxed twice—once when corporate profits are taxed, and again when they receive personal income from those profits. Keep in mind, however, that S-corps benefit from pass-through taxation as well.
- Profit Distribution – In an LLC, members can agree to divide profits or make distributions as they see fit, as opposed to corporations, which must distribute profit and loss based on how much stake each shareholder has in the company.
- Flexibility and Freedom – LLCs are very “malleable.” In essence, because they are entities based on principles of contract and except for a few minimum standards imposed by statutes, an LLC can be “molded” into anything that the owners want. LLCs also usually face fewer state-imposed regulations and are not hampered by required corporate formalities like board and shareholder meetings.
There are also some disadvantages to incorporating as an LLC rather than a corporation, which we’ve also listed below.
- Cost – The cost of formation for an LLC can actually be much higher than that of a corporation. Because LLCs are so “malleable,” they tend to be much more customized from company to company. Corporations, on the other hand, must have certain governance procedures that cannot be significantly changed.
- Venture Capital –
- Taxes – By virtue of pass-through taxation, LLC members are required to file self-employment taxes since they are not technically considered employees of the LLC. This can be a complicated process and involves quarterly estimated payments to the IRS. Plus, LLC owners will be personally taxed on the company’s profits regardless, whereas a shareholder is only taxed on dividends he or she receives and could choose to leave money in the company so that he or she is not personally taxed on it in a given year.
- Ownership and Operating Agreements – Transferring membership interests in an LLC due to a member leaving can be a difficult process. Operating agreements, which generally dictate the terms of ownership and may include buy-sell agreements, can be extremely complicated as well.
Deciding which business entity to choose when looking to incorporate your business can be a daunting proposition since there are advantages and disadvantages to both. If you want to incorporate your business, give Doida Law Group a call to discuss your options and figure out if an LLC, corporation, or some other entity would be right for you.