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Corporations Vs. LLCs

Aug 17, 2007
Limited Liability Company

Limited Liability Companies are a relatively new form of business entity. The first ones where created in 1979 in Wyoming. They became popular and soon all states had LLCs available. Because they are such a new entity, the rules for operating them vary from state to state and even between the state and federal laws. Over the past five years, the laws regarding LLCs have been in a constant state of change.

A Limited Liability Company has liability protection. If some one sues your company they can only go after the assets of the LLC, not your personal. (This of course is contingent upon you keeping up with all the requirements of an LLC). The current laws requires all partners to be taxed the same as a sole proprietor. This is a flow through entity which means that all the income and Social Security taxes are paid on the members personal tax returns. The IRS currently requires a minimum of two members of the LLC even though some states only require one member.

The LLC is good for three major things. Firstly, it good for companies whose members have a different percentage of profit ownership and liability. For example, two people form a LLC. One has the idea and puts in a lot of time and the other just invests the start up funds. They may want to have equal ownership but the one who invested the money may want a higher percentage of the profits until the funds are repaid. An LLC will give you this flexibility.

Secondly, LLCs are good for one time projects were multiple people come together. When setup properly you can avoid security issues and distribute profits according to how you want.

Thirdly, a LLC is a good place to hold investment property. A LLC is good for this purpose because there is no Social Security tax on capital gains and rental income. So you still get the personal asset protection without worrying about paying Social Security tax. Also, property can be moved in and out of a LLC without causing a taxable event.

In addition, if someone sues you personally they can go after your ownership in the LLC. If they win and are able to gain control of your ownership, if setup properly, the LLC has the flexibility to distribute profits and control however it wants. So, you can give all profit rights and control rights to the other partner and the person who took control of your ownership still has no power to receive moneys or control the activities of the LLC.

Ownership in a LLC can be willed, sold or assigned to another incase of the death of a member.

C Corporation

A Corporation is an entity that is separate from the owners, or stock holders. Because it is an individual, if the corporation gets sued, only the assets in the corporation can be attached. This means that the personal assets of the stockholders are protected. A C-Corporation has the greatest liability protection. Also because a corporation is a separate entity, it pays it's own income taxes. The corporation is required to pay the officers a salary and it must pay anyone that performs a service for the corporation as an employee or contract labor. But the stockholders can receive distributions of money in the form of dividends. The dividends are a portion of the profits of a corporation distributed according to the amount of stock each stockholder owns. The stockholder's personal income tax is only affected by the W-2 received from the corporation and the amount of dividend income received.

Depending on the state you incorporate in, a corporation generally requires a minimum of three individuals as officers and directors to operate the corporation. It is also required to hold yearly meetings.

Sub Chapter S Corporation

A Sub Chapter S Corporation is different from a C Corporation because the IRS codes that apply to it are under the Sub Chapter S section. A S-Corporation is also a separate entity from it's stockholders. However, like the Limited liability Company, it is also a flow through entity. This combination offers some interesting advantages. The S Corp offers liability protection for it's stock holders. As long as the rules are followed, in the case of a lawsuit, only the assets in the corporation would be at risk.

The S Corp is also required to pay a minimal salary to the officers, and pay anyone who performs a service for the corporation. However, because it is a flow through company, the profit or loss from the company flows through to the stockholder's personal tax return. The advantage of this is, that if the company shows a loss at the end of the year, it will count against any other income the stockholder may have. For example, if one spouse has a job and gets paid with a W2 form, and the other spouse has losses from a S Corp, then the losses will lower the overall income and the couple will pay less taxes. If the corporation shows a profit, that profit will be reported on the tax return in a way that the stockholder will be able to avoid much Social Security tax. That is a savings of at least 15% in taxes over the sole proprietor.

In most states only one person is required to be the director, officer and registered agent for a S Corp. That means that if you want to be the only one to run and operate your company, you can. The stock in the S Corp also can be willed or assigned to others incase of death.

If you hold investment property in an S Corp and you want to move that property out, you are causing a taxable event. You must sell the property for full market value, thus causing you to pay undo capital gains taxes. If you put the investment property in a LLC you can avoid this problem.

If you get sued personally you can get sued for ownership in your S-Corp. If the person suing you won and got control of the ownership they would be able to effect the activities of the S-Corp and would be required to receive funds according to the ownership. To avoid losing possible funds, contact an attorney as soon as you find out someone is trying to sue you. A law suit is like a time line and there is much structuring and liquidating you can do before it is time to settle or go to court. Your attorney can help you do this so when it comes time to settle you can say the magic words, "you can sue me but I don't own anything."

This information does not constitute as legal advice. Please contact an attorney for specifications of entities in your state and for further questions and concerns.
About the Author
Christopher Anderson is part owner of Lone Peak Business Solutions, Inc. He wants to share his success as a business owner with others who desire to own their own business. He also believes that the economy is stronger with more business owners, and as a result, he is focused on helping business owners succeed.
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