KPMG Spark Blog
If you are setting up a business then one of the most important decisions you will need to make is the company structure you choose for that business. Two of the most popular business structures are corporations (also known as Inc., which is short for incorporated) and limited liability companies (LLC).
While both of these business structures offer limited liability that will protect your personal assets in case of a lawsuit against the company, they are unique from one another in terms of management, structure, and taxation. Understanding the advantages and disadvantages of each company structure will give you a better idea of which one is right for your business.
For many people, taxation will be the main driver behind whether they choose to establish their company as a corporation or an LLC. If you choose to form your business as an LLC then you will be subject to "pass-through" taxation. What this means is that the business itself will not pay taxes. Rather, those taxes are paid by the individual members of the LLC and the losses and expenses that the business generates will be reported on individual tax returns.
Corporations can be quite different depending on the type of corporation your business is. An S corporation is, like an LLC, a "pass-through" tax entity, so the corporation itself is not taxed and individuals can use business expenses as deductions on their personal tax returns. A C corporation, on the other hand, is a separate entity and is taxed separately from its shareholders, members, and directors. Corporate income splitting can also result in lower overall tax obligations for a C corporation. However, shareholders may also have to pay taxes on any dividends that are paid out to them by the corporation, leading to "double taxation."
Aside from S corporations, which are limited in size and may be profitably used by self-employed individuals, corporations are generally suitable for large entities. Corporations are owned by the shareholders of that company and are operated by the officers. Officers are appointed by the board of directors and the board of directors are, in turn, elected by the shareholders. Because of the complex structure of a corporation and the fact that the directors and officers are accountable to the shareholders, there tends to be limited flexibility in how much control one individual can exert over the corporation. Furthermore, corporations are required to record minutes and hold annual meetings.
An LLC, on the other hand, is often a more appropriate structure for a smaller business entity. An LLC has members instead of shareholders. Members exert a great deal of control over the day-to-day operations of the company. Members may also appoint managers to limited terms who carry out various duties in maintaining and administering the affairs of the business. While members do enjoy greater flexibility in how they operate the company, LLCs cannot issue stock, which may make raising capital more difficult.
Forming an LLC is generally easy and does not require a burdensome amount of paperwork. While requirements differ from one state to the next, in most states LLCs require a document called either the "rules of organization" or the "articles of organization." Some states may also require an "operating agreement," which stipulates how the company's income, management, membership, and general operations are to be structured.
Forming a corporation is more complicated and certainly more expensive than forming an LLC. A registration fee, which can run into the thousands of dollars in some states, will have to be paid. Additionally, the Articles of Incorporation will have to be filed and this document will lay out such vital information as where the corporation is located, what business activities it is engaged in, and how many stocks (and of what type) it will be issuing.
A corporation will also need a name that is distinctive and which also describes the main activities of the corporation. In some states, the name will have to include "Inc." at the end to distinguish it from other business structures.
Setting up a new business or changing the structure of an existing business presents many unique and exciting opportunities in terms of your company's structure. Incorporation and LLCs offer similar benefits in terms of liability, but they differ substantially in terms of taxation, structure, and formation. It is crucial that you understand these differences as they could be the elements that determine the success and profitability of your business moving forward.
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