LLCs/Corporations

What is a Corporation?
A corporation is a legal entity; that is, a corporation is seen as a person under the law with its own rights and liabilities.  The corporation’s rights and liabilities are different from the individuals who make up the corporation.  The rights and liabilities of a corporation include raising money, forming contracts, filing suit, being sued, and paying taxes.

How is a corporation organized?
The minimum qualifications for a corporation are at least one director, officer, and shareholder.  The corporation is managed and administered by directors while its officers hold positions such as president and secretary.

Types of Corporations:

  1. C Corporation – C corporations are taxed twice.  They are first taxed on its corporate income, then its stockholders pay income tax on their distributed profits.
  1. S Corporation – S corporations are able to be taxed only once via becoming a pass-through entity by making a special election to be taxed.

What are the advantages of forming a corporation?
Corporations have many advantages:
(1) Limited Liability – owners and stockholders are not personally responsible for paying corporation debt, so creditors cannot for after them.

(2) Flexibility with Continuity – ownership may change easily with the selling of shares, yet the corporation as a person continues unchanged with the changes in ownership.

(3) Tax Advantages – small businesses are able to take advantage of significant tax savings.

(4) Raising Funds – lenders more easily lend money to corporation.  Also corporations may raising money by selling corporation stock.

What is a Limited Liability Company (LLC)?
An LLC is a business entity, which combines elements of a corporation, partnership, and sole proprietorship.  An LLC is created under state law and unincorporated, yet it may behave like a corporation by raising funds, adding new members, and limiting liability.  The concept behind an LLC is to allow members (owners/partners) to share in the ownership benefits while risking only liability of their investment in the company.  That is, if an LLC files for bankruptcy, a member will lose their investment in the company but will not have to pay any outstanding company debt.  However, an LLC behaves like a sole proprietorship or partnership in its operation flexibility and its pass-through tax status.

LLC compared to Corporations
Advantages:

  1. Less Red Tape – Unlike corporations, who must hold file annual reports with the state and conduct board of director and shareholder meetings regularly, LLCs are free to meet as often as the members feel is necessary.  This lack of formality, cuts costs and time.
  1. Ownership Flexibility – LLCs do not have member restrictions whereas some corporations must limit the amount and citizenship of its owners.
  1. Cash Method of Accounting – LLCs have the option of using the cash method of accounting, only earning money when it is received.  Corporations often use the accrual method of accounting.
  1. Ease of Estate Planning – Shareholders sometimes experience difficulty placing their shares in a living trust, but LLC members easily place their membership interest into a living trust.
  1. Loss Deduction – Active members of a LLC are able to partially deduct the LLC’s operational losses against the member’s income.
  1. Tax Flexibility – An LLC can choose to be treated as a corporation for tax purposes, or it can enjoy pass-through status.  Pass-through status allows the LLC to evade double taxation.

Disadvantages:

  1. Profits taxed for social programs – For LLCs, unemployment tax is taken out of both salaries and profits.  In addition, Social Security and Medicare taxes are taken out of the LLC’s profits.  As a result, LLCs may pay more taxes than corporations.
  1. Profits must be recognized immediately – Because of the pass-through status, members profits automatically become included in member’s income.  However in corporations, shareholders are not always taxed on corporation profits because the profits are not realized right away.
  2. Less fringe benefits – existing fringe benefits in an LLC are taxable income whereas for some types of corporation, the fringe benefits are not taxable income.