Selecting the appropriate legal structure is a crucial decision when starting a business. Two common options are corporations and limited liability companies (LLCs). Both corporations and LLCs are separate legal entities independent of their owners, allowing them to own assets, enter into contracts, and sue and be sued in their own name. Also, both entity structures offer limited liability protection, which means that the owners’ personal assets are generally shielded from the company’s debts and liabilities beyond the owners’ investment. Yet, each entity has its own advantages and considerations. This article aims to highlight certain aspects of each entity structure, helping you make an informed choice for your business.
Ownership and Management
Corporations have a more formal and complex ownership structure. Ownership is divided into shares of stock held by shareholders. The shareholders elect a board of directors who then appoints officers (for example, CEO, CFO) to oversee daily operations. The structure of a corporation is ideal for larger companies with multiple shareholders and personnel working in a hierarchy.
In an LLC, ownership is divided into membership interests, and the members can be individuals or other entities. LLCs offer greater flexibility in structure and management than corporations in that they can be managed by the owners (member-managed) or by managers (manager-managed). This allows for a streamlined decision-making, especially in smaller businesses.
Taxation
Corporations are taxed as separate entities, paying taxes on profits. Shareholders may also face additional taxes on dividends they receive, leading to potential “double taxation.” Certain corporations, known as S corporations, can elect to pass through their income to shareholders, avoiding double taxation. Corporations have more tax planning options. They can structure salaries, dividends, and other distributions to optimize tax efficiency for the owners and the business, which is particularly advantageous in complex financial arrangements.
In contrast, LLCs are pass-through entities, meaning profits and losses pass through to the members who report them on their individual tax returns, and who are then taxed at their individual tax rates. This avoids double taxation. LLCs have flexibility in choosing their tax classification, and can be taxed as corporations, if desired.
Formalities and Regulations
Corporations are generally subject to more formalities and ongoing compliance regulations than LLCs. They must hold regular meetings of shareholders and directors, maintain meeting minutes, and comply with reporting and record-keeping requirements. Failure to comply with these formalities may jeopardize limited liability protection.
LLCs generally have fewer formalities and less paperwork compared to corporations. Setting up an LLC usually involves filing articles of organization with the state, whereas corporations require more extensive documentation, such as articles of incorporation and bylaws. Ongoing compliance requirements for LLCs are typically less burdensome.
Future Goals
Consider the future goals of your business when choosing between a corporation and an LLC.
Corporations are better suited for ambitious growth plans and attracting outside investors. They generally have an easier time raising capital compared to LLCs. Corporations can issue different classes of stock to attract investors by offering various rights and preferences. Corporations can also issue public stock and raise funds through initial public offerings (IPOs).
LLCs offer flexibility in distributing profits among owners. Profits can be distributed unevenly based on the members’ ownership percentages, whereas corporations typically distribute profits based on the number of shares owned.
Consult with Legal Counsel
It is important to note that rules and regulations governing corporations and LLCs vary by jurisdiction. Additionally, the advantages of each structure depend on factors such as business size, growth plans, access to capital, and the specific goals of the owners. Seeking guidance from legal and tax professionals will help you determine the most suitable entity structure for your business. Schedule a consultation with attorney Olesia Y. Belchenko, who can provide legal advice tailored to your circumstances.
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