Small businesses need to form a entity for irs tax purposes, protection from lawsuits, and to increase their ability to raise capital for expansion. Which designation they choose will have a profound effect on how the business pays taxes, declares income, and protects its owners or board members. There is an ongoing discussion about the llc vs inc designation, and whether it is smarter to form the latter or incorporate with a C or S corporation.
Llc Pros and Cons
The formation of a ‘limited liability company’ is one formed by a single proprietor or several members. It is considered a separate entity and protects the owners from double taxation. Forming an llc is a simple process begun at the state level. Simple forms are filled out listing the owners and members as well as their personal and business information. The irs allows ‘pass-through taxation’ which means each member is responsible for a portion of the profits and losses equal to their investment.
The members of the limited liability corporation are sheltered from liability when incurring obligations during the course of business. In theory, claims may only be against the LLC, and not against the individuals involved in it. However, if any member guarantees an obligation, they can be held liable for it. LLC’s are also a flexible business structure, unlike corporations which have strictly delineated hierarchies.
Incorporated Companies
To incorporate a business, the company files the ‘articles of incorporation’ with the state. After the required public notification waiting period, they can conduct business within the protection of either an ‘S’ or ‘C’ classification. As with an llc, the company is considered unique from its owners for purposes of taxation and liability issues.
Shareholders are the owners of the business, but are not technically obligated to pay its debts, enjoy any privileges afforded by this classification, or be held legally liable for damages incurred by the business. ‘C’ corporations will pay tax on earnings, and its shareholders pay tax on dividend distributions. ‘Pass-through’ taxation, which passes the tax liability onto the shareholders, is only possible when incorporate in ‘S’ status.
The advantages to incorporating are many; shareholders in either classification are only at risk to lose their investment. In most cases, personal property or assets outside of the corporation can not be sought after for damages. An incorporated business is a sound structure which will endure even when individuals are sued or leave the company.
An important advantage of a ‘C’ or ‘S’ corp. is its dependence on shareholders. Once this entity is created, ownership is easy to transfer through the sale of the company’s stock. Further, although the LLC prevents double taxation, the members may have to pay income tax on businesses purchases paid for by the business when it has not shown a profit. Incorporated companies who offer employee benefits can deduct these contributions. For this reason many businesses choose to match 401k contributions or provide pension plans for their employees.
Both llc and inc classifications have their advantages, the right choice depends on how large the business will grow, and how much protection the owners will need in the future.
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