If you're uncertain about the type of business structure you should set up, you're not alone. Many people go back and forth on the type of business entity they should set up. One of the biggest questions we get asked is regarding corporation vs. Limited Liability Company (LLC).
The main difference between an LLC and a corporation is that an LLC is governed by a contract between the members. A corporation, on the other hand, is governed by statute. LLCs provide more flexibility to their members and are usually the better business type choice for small businesses.
Advice flows like a river when it comes to owning a business. You might hear, “Do not form a Limited Liability Company (LLC)” or “forming a corporation is much too complicated for a small business owner.”
Please note, an LLC can be taxed as a Corporation - so you do not need to make this decision based on your preferred tax election. That is a common mistake we hope to help you avoid. You can also convert an LLC to a Corporation or vice-versa, so you don't have to get it 100% right at the beginning.
What is the answer to the question, “Should you form an LLC or a corporation?” It depends! Here is our executive summary, but we recommend reading the whole page:Choose a Corporation if you:
- Have many investors;
- Want to issue shares of stock as compensation; or
- Want officers' actions to be approved and overseen by a board (best if you have many employees and want to be hands-off)
- There is one owner, or the owner are family;
- You prefer simplicity and low fees;
- You need tax flexibility (LLC can be taxed as a Sole Proprietorship, Partnership, S-Corp or Corporation);
- There are no "outside" investors you don't know well;
- Charging order protection is needed;
There is also the related question of what state is the best to form a business. We will provide guidelines for cost, simplicity, taxes, privacy, and unique benefits and disadvantages for various business entities.
Both entities are ultimately operated for the benefit of the owners, called members (LLC) and shareholders (Corporations), with them receiving profits. Owners can vote, but their degree of immediate control differs.
In a Corporation, the Shareholders elect a Board of Directors, and the Board appoints Officers. The officers manage day-to-day business operations and are overseen by the Directors.
Shareholders cannot sign contracts, checks, etc. (unless they are also Officers).
In a Limited Liability Company, the Members can run day-to-day business operations, or appoint a Manager. This is all done within the operating agreement, and decisions don't require complex votes and additional documentation, e.g., board elections, bylaws, etc.
An LLC is taxed as pass-through taxation by default. This means there is no double taxation. You can elect for Corporate taxation if you determine this is better, but we advise speaking to a CPA to ensure it's the correct election.
A Single-Member LLC is a Sole-Prop (for taxes, not asset protection), and a Multi-Member is a partnership. You may also elect Corporate taxes (as noted above) or S-Corp taxation using forms 8832 and 2553, respectively. Again, please speak to a tax professional about what is best.
Corporate income is generally taxed lower than individuals, but you must file a separate corporate tax return, and when a distribution is made, then tax is paid again (referred to as double taxation).
Corporate Veil, Charging Order Protection
& Asset Protection
Corporate Veil (Limited Liability) Both an LLC and a Corporation enjoy limited liability, which is the legal principle that minimizes the exposure owners, and shareholders face in terms of lawsuits. Both types of businesses must keep company operations separate from the owners' activities to sustain limited liability protection. So long as general rules are followed, it is difficult for a business creditor to go after the owner's assets.
If a judge discovers the activity of the owners is not separate from the business, then both the owners and shareholders lose their limited liability status. This is referred to as comingling funds or the alter-ego theory when proper separation does not exist due to poor record keeping, for example. Other notable exceptions exist for fraud and inadequate capitalization.
It's important to note every state determines its LLC asset protection laws, so the above is general advice. The above is also why many seek out Wyoming LLCs given their aggressive asset protection benefits.
Charging Order Protection: The corporate veil protects business owner assets from business creditors, whereas charging order protection protects business assets from the liabilities of the owners.
For example, if you are in a car crash personally and found at fault, can your personal creditors attack your business? Most LLCs have a form of charging order protection, so your Membership Interest cannot be attached, however, your shares in Corporation can be seized.
An advanced asset protection technique is to hold your shares in an LLC to create a double veil and provide charging order protection.
Corporation & LLC DefinitionsLimited Liability Companies
- Articles of Organization / Certificate of Formation: These formation documents are filed with the state to open the company.
- Operating Agreement: This is a contract for owners to determine ownership percentages and responsibilities, e.g., how much cash to push it.
- Organizer: This is the person who submits the Articles or Certificate to the state, and their name is made public.
- Members: These are the owners of the company.
- Manager: These are formal positions in the company. Their responsibilities can be listed in the Operating Agreement or in an employment contract outlining the daily business decisions they have the power to make.
- Articles of Incorporation / Certificate of Incorporation: The document filed with the state to open the company.
- Organizational Minutes: These are used to appoint initial board members and officers, and determine where a bank account will be opened, along with other basic tasks.
- Bylaws: These provide the general structure of the company, and how the board will be formed when meetings will be held.
- Share Subscription Agreement: This document issues shares to owners/investors. See below for the difference between authorized and issued shares.
- Authorized Shares: How many shares can be sold or issued before additional permission is needed.
- Issued Shares: Shares that have been given to owners in return for cash or services. Note, issued shares must always be less than authorized shares.
Business Formation Differences
Businesses must register the type of business formed with the state where they do business. Forming an LLC involves the members filing an Articles of Organization with the primary state where the LLC conducts business. All members sign a contract that is referred to as an Operating Agreement that is used to manage the daily activities of the LLC. The Operating Agreement also defines each member's stake in the newly formed LLC.
For the formation of a corporation, Articles of Incorporation must be filed with the Secretary of State in the state where the corporation intends to establish a headquarters. The Articles of incorporation list the board of directors that is responsible for managing corporate business activities, as well as creating the bylaws that the corporation must follow when in operation.
Best State to Form
If you still cannot decide whether to form an LLC or a corporation, we can help you make the right decision. Once you've decided on the correct business entity, you should consider the best state. Many clients choose Wyoming or Delaware, but we can form in all 50 states. Read more here for the best state to form a company in.