One of the first decisions to be made when starting a business is how to structure the company. Most entrepreneurs will choose a Corporation or an LLC. Either of these structures allows the owners to establish credibility and professionalism and these structures also provide limited liability protection. Limited liability protection ensures that your personal liability for the debts and obligations of the business is no more than you invested in the business. This protects your home and other personal assets from your business obligations including lawsuits and bankruptcies.
Taxation is one of the first areas where we will see a difference between LLCs and Corporations. An LLC is taxed as a pass-through entity by default. This means the profits or losses are passed through to the owners which are the members.
Profits and losses are reported on the individual tax returns which not only is simpler but also has the added advantage of business losses and operating expenses can be used to offset other income. LLCs do have the flexibility of opting to be taxed like a C Corporation. This is not a common choice, but it could make sense for some businesses.
Corporations are taxed as a separate legal entity which makes its own income apart from its owners. Corporations must pay taxes on its income (corporate tax) and must also report any dividends paid to its shareholders. Dividends are after-tax profits paid out to the shareholders and are not deductible to the corporation but are taxable income to the shareholder.
This is referred to as double taxation and it is the single biggest argument against creating a Corporation. Because of this double taxation, corporations are granted some federal deductions that are only available to corporations.
For example, the fringe benefits paid to an employee like medical and retirement plans offset some of the effect of double taxation. Corporate tax rates were reduced in 2018 to 21% which is lower than the top five tiers of individual rates.
Ownership structure is different between a Corporation and an LLC. Corporations can sell shares of stock to its owners who are called shareholders. If your business wants to attract investors, then a Corporation is a far better structure for that purpose. Corporations exist in perpetuity regardless of the owners coming and going through the transfer of stock.
LLCs, on the other hand, by default must be dissolved if a member leaves unless specifically defined otherwise in the operating agreement. LLCs are more flexible in the ownership structure. Individuals, companies, or any kind of trust can be a member. Operating agreements can design any kind of set up for ownership shares and division of profits.
Management structure is far less formal in an LLC than it is in a Corporation. LLCs can be managed by any of its members. Corporations have to follow parliamentary type rules like having a Board of Directors, President, Secretary, and Treasurer even if one person holds all of the positions.
The ongoing maintenance required to keep your company in good standing is more involved with a Corporation than an LLC. Corporations are required to hold annual shareholders meetings and keep minutes of those meetings in their corporate minute book.
Both LLCs and Corporations are required to make annuals reports to the Secretary of State called Statements of Information which details who the directors, officers, or members are and therefore any changes.
As you can see, the most important thing about choosing the right structure is knowing what you intend to do with your business. This type of decision should be reached with the assistance of an attorney or a business consultant.
This information is not intended to replace or substitute for any professional or legal advice on any of the subjects discussed. It is purely informational.
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