Two of the most popular business entity choices are corporations and LLCs. These entities, when properly set up and operated, provide liability protection for the owners and can accommodate a variety of management styles. While corporations and LLCs offer many of the same benefits, they are not the same.
Corporations are treated by the law as a separate legal “person”. In the normal course of business, shareholders of the corporation are not liable for the corporation’s debts. The corporation can enter into binding contracts, sue and be sued. Corporations must be operated properly, however, otherwise shareholders may become personally liable for the corporation’s debts and obligations.
The laws governing corporate formation and governance vary from state to state. The law applicable to your corporation will depend on the state in which you form it. You might also be subject to other state laws depending on where the corporate offices are located or where the corporation does business. Talk to your business lawyer before forming your corporation to make sure you incorporate in the state most advantageous to your business and that you are knowledgeable about operational requirements that will apply to your operations.
C Corporations and S Corporations
Selecting the corporation as your business entity isn’t the only decision to make. You also have to select the way your corporation will be treated by the IRS. Your business lawyer can help you decide if a C Corp or an S Corp is best for you. Here are a few differences.
- Taxation: C Corps are taxed as separate entities, which may lead to double taxation. The corporation pays taxes on its income, then shareholders pay individual taxes on dividends. S Corps, on the other hand, can be taxed as pass-through entities avoiding income taxes at the corporate level.
- Ownership of the Corporation: C Corps generally do not have restrictions on who can be shareholders or limit the number of shareholders. C Corps can also have more than one class of stock. S Corps, however, generally cannot exceed 100 shareholders, shareholders generally cannot be partnerships, corporations or non-resident aliens, and there can only be one class of stock.
If you qualify and want to be recognized as an S Corp, each shareholder needs to sign IRS Form 2553 and then file the form with the IRS.
Taxes are a complicated area of law, but an experienced business or tax attorney can help you make the best decisions from the start.
Limited Liability Companies (LLCs)
LLCs were first recognized in Florida and Wyoming back in the 1970s, and they’re now widely accepted in all 50 U.S. states. The innovative aspects of the LLC revolve around bypassing many corporate formalities while providing favorable tax treatment and limited liability protection. LLCs can be very efficient way to conduct business.
LLCs are not required to have the same governing structure as corporations. Management and governance are left largely to the members’ agreement in an Operating Agreement. A well drafted Operating Agreement will define various roles and responsibilities of the members which helps focus the leadership and avoid unnecessary conflict. Even though the structure and operation of LLCs are more relaxed than corporations, members still receive protection from the LLC’s liabilities. In addition, some legal scholars argue that members of an LLC cannot be sued if he or she doesn’t follow corporate formalities, which is not the case for a member of a corporation. Be warned, however, that courts have found individual liability in LLC members by applying corporate governance rules to the LLC. The best course of action is to consult a business lawyer for advice specific to your situation.
Comparing C Corps, S Corps and LLCs
|C Corp||S Corp||LLC|
|Company name protected by state registration (not the same as a trademark)|
|Life of business is perpetual|
|Owners can include non-resident aliens|
|Profit and losses can be recorded on business owners’ personal tax returns|
|Allowed to issue shares of stock for investors|
|Unlimited amount of owners allowed|
|Limited liability available for debts and obligations|
|Allowed to be owned by another business instead of (or in addition to) individual owners|