The Advantages of Creating an LLC Instead of a Corporation

Tuesday, January 21st

The Advantages of Creating an LLC Instead of a Corporation

A limited liability company (LLC) is similar to a corporation in many ways. However, there are also many key differences between the two that you should be aware of when deciding how to structure your business. Let's take a closer look at the similarities and differences between these two structures and why forming an LLC may be the best way to run your company in an effective manner.

What Are the Similarities Between a Corporation and an LLC?

A corporation and an LLC are both entities that are separate from their owners. Therefore, assuming that you have followed your state's protocols for creating these entities, you should be able to shield yourself from personal liability for any harm that your business may cause.

For instance, if you were sued by a client, only the company's assets could be used to satisfy any judgment that the plaintiff may obtain. If you have business liability insurance, there is a good chance that it would pay the judgment on your behalf anyway. However, knowing that your home, car or other property can't be liquidated to cover your company's debts can provide you with extra peace of mind.

In addition, a corporation and an LLC may be taxed in a similar manner. However, it's worth noting that you must elect for your LLC to be taxed like a corporation for this to be true. This can be done by filling out IRS Form 8832 as quickly as possible after deciding that you want to change your company's tax status. A failure to do so will result in your organization being treated as a sole proprietor or partnership for tax purposes.

What Are Some Differences Between a Corporation and an LLC?

There are a couple of key differences between corporations and LLCs that may make the latter the best option for your company. For example, you can run an LLC without the need to have a shareholder meeting at least once per year.

Furthermore, there are fewer requirements as it relates to the types of records that this type of entity must keep. Therefore, if you are simply looking for limited liability and flexible tax treatment, the LLC structure may be preferable to running your business as a corporation.

Another issue to keep in mind is that corporations must pay taxes on their profits. If your organization is classified as an LLC, it's profits will be passed down to each member's personal tax return. Therefore, you can avoid what is often called double taxation.

Double taxation refers to the fact that a corporation's profits are taxed at the corporate level and at the personal level. Let's say that your corporate entity had a yearly profit of $100,000. That money will be subject to corporate taxes before it is distributed to shareholders. Let's say that you are the company's only shareholder and have $90,000 remaining that you want to give to yourself as a salary.

That money will now be taxed at your personal income tax rate, and you will also need to withhold additional funds for FICA taxes. If your state levies an income tax, you'll need to pay that as well.

Why Can't I Just Form an S Corporation?

An S corporation is similar to an LLC in that profits or losses flow directly to an owner's personal income tax return. However, it's generally in your best interest to form an LLC that elects to be taxed as this type of entity. This is because forming an actual S corporation means that you have to have an annual shareholder meeting, follow stringent paperwork requirements and other rules that may cost time or money to comply with.

It's worth noting that electing to be taxed as an S corporation may help you save money on employment taxes each year. This is because you are allowed to distribute a portion of your earnings as an owner's share as opposed to an actual wage. The advantage to classifying earnings as an owner's share is that you don't have to pay employment taxes on that income. Of course, the IRS can reclassify a distribution as a proper wage, so be sure to check with a tax professional if you have any questions about how you pay yourself.

You Can Allocate Ownership of an LLC However You Like

One of the best reasons to form an LLC as opposed to a corporation is that you can be an LLC's top shareholder even if you don't actually put any money into the company. Generally speaking, ownership in a corporation is directly proportional to how much money a person invests in that entity.

Therefore, it's possible that a group of shareholders could band together and buy a majority stake in your business without your knowledge or consent. This is called a hostile takeover, and it effectively negates your ability to control the future direction of your company. With an LLC, you can simply declare yourself the majority owner without any possibility of being bought out against your will.

It May Be Possible to Use an LLC as a Holding Company

It's not uncommon for a single entity to own a stake in a variety of different companies. For example, Disney owns companies such as Pixar, LucasFilms and Marvel Studios. It also owns a controlling stake in the sports network ESPN. To better manage its various assets, it has created a number of subsidiaries that are controlled by Disney itself.

Of course, your new business probably doesn't have the resources that a large company like Disney has. Therefore, if you plan on expanding your company in the future, it may make more sense to create a series LLC. The series LLC will be the controlling owner of an additional LLCs that you create to manage your company's intellectual property or other assets that it acquires over time. A series LLC functions much like a traditional LLC, which means that it will likely be easier to manage.

It's Easy to Form an LLC

Another great reason to form an LLC is that you can usually do so online and in a matter of minutes. Typically, all you need to do is submit a piece of paper to the relevant authorities in your state listing the name of the company, its address and who the state should contact if any problems arise.

If you submit incorporation documents online, you'll likely be able to keep track of where they are in the approval process. There is also a good chance that you will receive approval much faster than you would if you chose to mail or fax them.

You will typically pay a fee of between $50 and $150 depending on the state that your company is incorporated in. The state of New York requires you to publish a notice of incorporation in an approved newspaper for a period of several weeks after your company is authorized to operate there.

Although your LLC is encouraged to have an operating agreement, there is no requirement to do so. In most cases, you are required to have an operating agreement on file if you choose to operate as a true corporate entity.

Forming an LLC is a great idea

If you are in the process of starting a new company, you should strongly consider operating it as an LLC. Doing so will reduce the odds that you lose personal assets in the event that your business is sued, defaults on a loan or experiences other types of financial hardships. At the same time, the simplicity of the LLC structure means that it can be used by almost any company regardless of its size.