Determine Whether Your Business Should Be a Corporation or LLC

November 19, 2014 in ,

Once you’ve decided to turn your business into its own separate, legal entity, you need to choose the right structure. Corporations and limited liability companies are both very popular entities, and both help protect you by limiting your personal liability. There are, however, some key differences between the two structures, and the right choice for your business really depends on how you want to run it.

Corporation

Corporations have been around for a long time, so corporate law is fairly static and well understood. Disputes are usually quickly settled since arbitrators and courts can consult centuries of case law. Unfortunately, running a corporation can be complicated. One of the biggest draws of a corporation is the fact that you can sell shares of the company, and raise money through investments. However, you do have a fiduciary duty to the shareholders to maximize profits, and because corporations involve other people’s money, regulations are strict, so you can’t just run the company as you see fit.

Forming a corporation, then, means giving up quite a bit of control. Executives and a board of directors run the actual corporation. An executive role is very similar to any business owner’s – you effectively guide the day-to-day operations of the company – but both the board of directors and your shareholders have to be happy with how the company is being run, and formal actions taken by the board need to be documented. The law also requires that you have an annual shareholder meeting to allow people to voice any concerns, vote on major business decisions, and elect new directors.

Standard corporations are also subject to double-taxation. Since a corporation is its own legal entity, it technically draws an income through its profits. That income is taxed at the corporate level by the federal and, normally, state governments. Then the shareholders have to pay their personal taxes on any dividends that earned. In other words, any money you’re making is taxed twice – once at the entity level, and once at the personal level. Thankfully, you can avoid this if you are small enough by electing to be taxed as an S-Corporation.

S-Corporation

An S-Corporation is a normal corporation that elects to be taxed according to Subchapter S of the IRS code. When a corporation makes this election, any income earned passes through the corporation itself, untaxed by the IRS, directly to the shareholders. The drawback is the corporation cannot have more than 100 shareholders, and it can only issue one class of stock. And, while the federal government doesn’t tax income, some states have decided to collect a small tax on S-Corp earnings.

Limited Liability Company

Limited liability companies have not been recognized for as long as corporations have. Nonetheless, they are extremely popular – LLC formation actually outpaces incorporation by nearly two-to-one, and for good reason. Unlike corporations, which are run by shareholders, executives, and directors, members run LLCs. These members are normally the people who formed the company. While you can’t sell shares of the company like with a corporation, centralizing ownership makes running an LLC much simpler, as you can run it closer to the way you did when it was a sole-proprietorship or partnership. A limited liability company also has a pass-through tax structure automatically, meaning any money earned passes through the company, untaxed, to its members.

Now, it is important to note that you still have to run an LLC as though it is a separate entity. Even if you’re the only member, you should keep records of any major business decisions made, and have an operating agreement in place. It may feel odd to have an operating agreement with only one member, but codifying how the company will be run helps you prove that you are running the limited liability company like an LLC, rather than as a sole-proprietorship. And, if you later decide to bring on more members, an operating agreement ensures the company continues to be run the way you’d like.

At the end of the day, the final decision is yours. Every business is different, and has different needs. Carefully compare the different entities, and then ask yourself which would fit your vision for the company. Because this is such a major decision, we’ve actually created a handy tool to help you decide.

After that’s done, the next step is to start securing your brand.

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