Choosing between an LLC and a Corporation for your new (or existing) business can be a daunting decision. It is always best to consult with an attorney to discuss your concerns and specific needs, but these tips should help lay a foundation to help answer to this difficult question.
1. For Less Paperwork, Choose an LLC!
States require various documents to set up both LLCs and corporations, but corporations require more documents both up front and ongoing. LLCs must file Articles of Organization and, while not technically required in most states, it is strongly encouraged for LLCs to also have an Operating Agreement.
Corporations must file Articles of Incorporation and sometimes must, and are always encouraged to, have Bylaws, issue stock certificates, and enter into Shareholder Agreements. Corporations are also required to hold annual board meetings and shareholder meetings where decisions can only be made if a “quorum” is present (lawyer-speak for a type of majority). They must also record and file minutes from these meetings. With all of these extra corporate formalities, it typically takes less time to create and maintain an LLC, which means you can pay your lawyers less, too!
2. If Seeking Investment, Choose a Corporation!
There are more intricacies involved in investing in an LLC than a corporation, so choosing to only invest in corporations is very common in the investment community. LLCs sell membership interest in their company, which means interest is sold as a portion of the whole. For example, if there are currently two founders each with a 50% share of the company, somebody or both will have to give up a portion of their share in order to allot a certain amount to a third person, an investor. Now this investor owns a piece of the company and will receive a K-1 statement each year indicating her share of the profits and losses from the company. She will file the K-1 on her personal income tax return annually, and will have to pay taxes on any profits from the business, even if the business decides not to issue profit shares to its owners (i.e. reinvest those profits in the business). Many investors choose not to invest in LLCs because of the paperwork and taxing scheme.
Alternatively, a new corporation is granted a certain number of shares when it incorporates. The founders must choose how many to keep for themselves, how many to sell off to investors, and how many to divvy up to new employees. When a corporation sells a share of stock to an investor, the company gets the money that the investor put in and the investor gets to hang on to the stock (with her fingers crossed that the company will succeed and the value of the stock will increase). The investor will pay tax on her shares of stock if the value increases in a given year (called a capital gains tax) or if the company pays out a dividend to its shareholders. Many investors prefer the simplicity and passiveness of owning stock in a corporation and avoiding the tax complications that come with buying shares of an LLC, and most venture funds simply will not invest in LLCs.
3. For Simpler Taxes, Choose an LLC!
LLCs are taxed just once. As noted above, owners pay personal income tax on their allocated share of profits, calculated and paid via their personal income tax return. There are no business taxes to pay.
Corporations, however, are taxed twice. First, corporate business tax is paid on the business income. Then, when profits are distributed as either wages to employees or dividends to shareholders, that money is taxed again on the personal tax return of the receiver. However, one advantage to the two-prong corporation tax is the ability to leave profits with the company. This means the money is not distributed as wages or dividends, therefore avoiding that second level of taxation. While this can be very advantageous, especially for a highly successful company, it can cause a lot of unnecessary confusion for a small company that intends to stay small.
4. For More Ownership Flexibility, Choose an LLC!
LLC founding members can dictate many operational specifics, such as ownership interest and perpetuity of the company, in the company’s governing documents. Members of an LLC can be granted disproportionate shares in their equity and ownership by simply saying so in the Operating Agreement. It is very easy, for example, to give a member 80% ownership when their capital contribution is only 50%. This means that the member provided half of the business’s equity, and is now receiving 80% of its profits. Corporations do not have this flexibility with their shareholders – the ownership percentage is always proportionate to the equity contributed.
Owners beware! An LLC might self-terminate if one member dies or leaves the business, even if the other members would like to keep the business going, unless the LLC specifically chooses perpetuity. Declaring perpetuity in the Articles of Organization and the Operating Agreement, and specifically indicating that the LLC will not automatically dissolve upon the dissociation of any one member, can easily adjust this default rule.
5. To Protect Your Personal Assets, Choose Either!
LLCs and corporations will both protect your personal assets from your business’s debts and liabilities. Your liability to repay the business’s obligations is limited to what you have invested in the company, never more. Therefore, your personal assets are protected from any failure or liability obtained on behalf of your LLC or corporation, so in either case you do not need to worry about company debts taking a bite out of your personal life.
**Disclaimer: _**_The information in this article is presented for informational purposes only, and should not be taken as legal advice. Before acting on any information presented in this article, you should consult an attorney regarding the facts of your specific situation. We would love to hear from you, so please feel free to __contact us_ for a free consultation._
Photos by Whitney Schey