The main benefit of incorporating your business (or forming a Limited Liability Company) is to protect your personal assets from the liabilities of your business. Having a formal entity can give credibility to your business as it shows you have taken formal steps to set it up and have the follow-through to maintain the company. Corporations and LLCs continue to exist even if ownership or management changes. Sole proprietorships (and partnerships, to some extent) end if an owner dies or leaves the business. Both corporations and LLCs may deduct normal business expenses, including salaries, before they allocate income to owners. There are tax consequences which arise from establishing your business as either a corporation or a LLC, but depending on your goals, you may be able to avoid double taxation of profits.
Should I form an LLC or corporation? Choosing the form of entity for your new venture depends on your goals. Sitting down with your attorney and your accountant will help you sort through the differences and come up with the right choice.
Corporations require more formality (and therefore more potential expense): a formally elected board of directors, statutory officers, stockholders meetings, class votes on certain issues, and records of meetings. While LLCs have some formalities they must follow, the rules and requirements are not generally as strict or burdensome as the formalities that corporations must follow. For example, the laws do not generally require LLCs to have any annual meetings (although some LLC operating agreements require meetings – but that’s a choice you make at the time you are organizing your company).
Corporate law is better developed and thus more predictable, should there be any litigation. However, as the LLC entity is becoming more common, the law regarding such entities is developing as well.
C Corporations result in higher overall tax payments through “double taxation”. A business operated in corporate form must pay federal and state income tax on the corporate level. When those earnings are distributed by way of dividends, they ordinarily generate additional tax again, payable by shareholders.
Both LLCs and S Corporations avoid double taxation because all company profits are “passed through” and reported on the personal income tax return of the shareholders or, in the case of an LLC, the members. S Corporations have limits as to the number of shareholders (no more than 100) and their citizenship (all individual shareholders of an S Corp must be either U.S. citizens or permanent residents, with a few limited exceptions). Also, shareholders must be natural persons, so corporate shareholders and partnerships are generally excluded. In an LLC, income and loss can be allocated disproportionately among the owners. By contrast, in the S Corp, income and loss are assigned to each shareholder strictly based on their pro-rata shares of ownership.
If your company is considering raising venture capital, VC firms are traditionally more likely to choose the C Corporation as the type of legal entity for their investments (this relates back to the predictability of corporate law, and the fact that it is very unusual for LLCs to go public).
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