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What is a Corporation?
When you incorporate a business, you evolve from a sole proprietorship (or general partnership) into a company that's formally recognized by its state of incorporation. In other words, it becomes a legal business entity of its own - separate from the individuals who founded it. The new company structure often falls into two categories: a Limited Liability Company (LLC), or a Corporation (Corp). In this article, we will be focusing on LLCs, as well as two popular types of corporations - an S Corporation (S Corp) and a C Corporation (C Corp).
No matter how you choose to incorporate, there are certain benefits you can expect. The most important benefit is being shielded from personal liability. This means that if someone gets a money judgment against the LLC or Corp, the judgment creditor cannot collect against your personal assets as a member or stockholder. Another benefit is an increased credibility with customers. There are also additional advantages and disadvantages associated with each incorporation type.
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Limited Liability Company Benefits
LLCs protect business owners, also referred to as members, from being held personally liable for the actions of the LLC. This limited liability typically protects you from the personal risks involved if a lawsuit were to arise concerning your business - safeguarding your personal assets. A couple additional benefits of an LLC include:
- Flexibility in management. Corporations have a set management structure where directors oversee the major business decisions and officers are responsible for the day-to-day running of the business. LLCs do not have the same formal management structure.
- Pass-through taxation. With pass-through taxation, taxes are not paid at the business level. If you choose to become an LLC, income/loss would be reported on your personal tax return. If any taxes were due, they would be paid on the individual level.
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LLC vs. Corporation: Other Key Differences.
We've already noted taxation and management as two distinctions between LLCs and Corps, but there are other key differences worth highlighting, including:
- Business Losses. The "S Corporation advantage" allows business owners to use business losses - like those incurred during the startup phase - on their personal tax returns as deductions.
- Self-Employment Taxes. An S Corp can provide savings on self-employment or Social Security/Medicare taxes, and it allows owners to offset non-business income with losses from the business - unlike a C Corp which is a completely separate tax entity.
- Ownership Restrictions. Neither the LLC nor the C Corporation has restrictions on the number of owners the business can have or who can be an owner. S Corporations, however, have a number of restrictions. S Corporations can have no more than 100 owners, and owners cannot be "non-resident aliens." Additionally, S Corporations cannot be owned by C Corporations, LLCs, other S Corporations or non-qualified trusts.
- Dividends and Venture Capitalists. C Corps are often the preferred incorporation choice of developing businesses. Owners can hold different types of stock interests (including preferred and common stock), which allow for different levels of dividends. This is one reason why venture capitalists choose C Corporations when they offer funding to a business. Investors are attracted to the prospect of dividends (often higher dividends) if the corporation makes a profit.
- Earnings. C Corps can retain and accumulate earnings (within reasonable limits) from year to year.
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Making Your Choice.
If you have more questions in trying to decide between an LLC or Corporation, please come in and see our attorneys and they can explain these differences and benefits in greater detail. However, it is our belief that no business should operate without being an LLC or Corporation and risk the choice of being personally liable for operating the business.
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