Forming an LLC or Business Incorporation: Which One Should I Choose?

by: Scott Weddle

I can’t tell you how many conversations I hear every day that start with the question “I’m thinking about forming an LLC or maybe a business incorporation. Can you tell me which one I should do”? I really wish it was as simple as telling one person that forming an LLC is right for them and then telling the next that business incorporation is the answer, but it is way more complicated than that.

To confidently answer that question would require intimate knowledge about the individual and his or her complete business plan. For example, how many owners will there be, do you need to raise capital through the business, and will you benefit from having the ability to pass taxes through to your personal return? These are just a few of the questions that come to mind when trying to determine what entity type is best. To make this discussion more useful, let’s take a look at forming an LLC and at business incorporation from an unbiased perspective and review how they work without trying to determine the pros and cons. This chart shows a variety of entity types and simplifies the discussion by clarifying what each type is capable of:

 

Feature	C Corporation	S Corporation	Limited Liability Company	General Partnership	Sole Proprietor
Provides owners with limited liability for debts and other business obligations
Company name protected by state level registration
Duration of the business can be perpetual
The number of owners may be unlimited
Owners may reside outside the United States and/or not be U.S. citizens
May be owned by another business
May issue shares of stock
Business profit may be passed through to the individual owners tax returns
The business and it's owners may split overall profit and loss, resulting in lower tax rates
Does not require annual meetings or meeting minutes

*As you can see, General Partnerships and Sole Proprietorships are clearly the most restrictive and neither one provides the owners with protection from liability, which is why they are not included in this conversation.

Forming an LLC or a business incorporation offer the most significant benefits to owners, however look carefully at these distinct differences before making a choice:

1. Raising Capital-It is possible to apply for loans or grants with either an LLC or a Corporation, but if your goal is to take your company public, only business incorporation makes that possible. Forming an LLC will not allow you to issue shares of stock. Only a tiny fraction of the businesses started ever go public, so this doesn’t affect most people but if your plan involves issuing stock, your choice is already made.
2. Pass Through Taxation-This one isn’t quite so clear cut. An LLC can pass profits and losses straight through to the owner’s tax return, while a Corporation cannot. That is unless the Corporation files for S-Corporation status with the IRS. With S-Corp status, profit and loss can be passed through, but then the corporation losses several of the benefits of being a corporation. I often hear people describe S-Corps as a very complicated limited liability company. Look carefully at the chart above before you decide on this one. Most of the people I talk to seem to go in the direction of forming an LLC rather than an S-Corp, but you need to understand what you gain and lose.
3. Split Profit and Loss-This is another double-edged sword. When people talk about the common concern of double taxation that exists with business incorporation, it is always negative. However, that same practice of having the corporation pay taxes first and then the individual pay takes on the salary they take from the company after taxes have already been paid at one level does provide for benefits in some cases. It is possible to alter your tax rate by leaving more money in the corporation or by paying more money out in salary. This is very complex. Do not decide on a business incorporation based on this reason without fully consulting with your accountant.
4. Annual Meetings and Minutes-This is a big one to many small businesses. Corporations are required to keep complex records of every meeting and of decisions made in those meetings. It is a very formal process, that when done incorrectly is an easy way for the corporate veil to be pierced and for your liability protections to vanish. If you are forming an LLC, you don’t have to worry about this one. You are not required to do anything like this. Ask yourself if you are the type of person who enjoys paperwork and how likely you are to keep these records up to date. Be honest.

You can easily see that it’s impossible to answer the question we opened this discussion with in a quick conversation. We have quite a bit more information on this and similar topics throughout our site to help you, but choosing between forming an LLC and business incorporation requires doing your homework.

• General Topics
• How To...
• Tax Matters
• Legal Matters
• Loans and Financing