One of the most common questions about starting a business is which legal entity a startup should form. If you’d like to know how to decide what kind of business to form, you’re in the right place.
A handful of different business structures exist in the United States. While tax laws may be different from state to state, all states will recognize whichever legal structure you choose. Small business founders essentially have two options when working through how to choose a corporate structure; LLC or Inc. LLC stands for Limited Liability Company. Inc stands for Incorporated or corporation. These are both legal entities and both LLC and Inc. have their advantages and disadvantages for entrepreneurs. These will be explained in more detail in this article. You should also be aware that the legal entity and tax entity can be handled differently. For example, you can decide to have your LLC taxed like a corporation. Thus, you may decide one structure is best for legal purposes but you’d like to be taxed under another.
Startup founders and small business entrepreneurs have a lot of important decisions to tackle as they build their businesses. One of those questions is whether you should start an LLC or an Inc for your business. In this article, we will tell you everything that you need to know about LLCs and Incs., to help you make an informed decision.
What is an LLC?
LLC stands for Limited Liability Company. It can be managed by a single owner, or by multiple owners, who are known as LLC “members.” If an LLC has one owner, it is referred to as a “single-member LLC.” An LLC with two or more owners is known as a “multi-member LLC.” An LLC has the ability to provide limited liability (thus the name) to its owner or members in a number of situations, though it is not as protective as a corporation or inc.
A good number of founders often choose the option of forming an LLC as a way of creating a wall between their company’s financial liabilities and their personal assets. Forming an LLC is the simplest and most flexible way of structuring your business for protection from things like lawsuits. An option like a sole proprietorship or a simple partnership will not be able to guarantee this form of protection to the business owners and members. The LLC grants business owners flexibility to elect corporate tax rules, direct pass-through rules, or even not-for-profit status.
In essence, forming a limited liability company structure for your business is the most flexible and approachable option of creating some legal protections for the founders. An LLC also provides your company credibility while preventing your business from getting taxed more than once. We will dive into more detail concerning the benefits than an LLC offers in our later section, “benefits of an LLC.”
If you are looking into forming an LLC in Omaha, or Nebraska, you must submit a certificate of organization for filing, and must choose a registered agent who is “designated as the entity’s agent for service of process and official government communications.”
LLCs are also required to file biennial occupation tax reports in odd number years, which is due on April 1st and delinquent June 2nd of the reporting year.
What is an Inc.?
Inc. is the abbreviation for an incorporated company, also known as a corporation. A corporation is a legal entity that is separate from the individuals or the group of people who are forming it. A corporation is formed according to State law. If you are looking to form a corporation in the state of Nebraska, owners must submit articles of incorporation for filing. Many startup founders and entrepreneurs will choose from their corporation in states that are business-friendly. For example, many businesses find Delaware to be the best state to form a corporation. Today, around half of the Fortune 500 companies have formed their corporations in Delaware.
A corporate structure has many benefits when it comes to legal protections for owners, but it requires rigorous reporting mechanisms. It requires a board of directors who are responsible for managing the corporation’s officers and leadership. The company board is responsible for issuing stocks, handling corporate meetings, recording the time of meetings, electing directors, and conducting business by resolution. The structure of a corporation works by having corporate officers (CEO, CFO, COO, etc.) responsible for operations by purchasing shares within the business. For example, a founder may become CEO and chairman of the board for a corporation but must have other board members now involved in the guidance of the company.
A corporation will typically offer more personal liability from debts or lawsuits than an LLC might. It is a separate taxpaying entity, which means that a corporation is responsible for paying corporate income taxes on its earnings and is responsible for its own debts. Essentially, a corporation stands alone and wholly separate from its founders. Corporations are more complicated and less flexible than an LLC, but can also be more protective and be viewed as more robust and professional.
Related: Omaha Startup Press for 2019
Benefits of an LLC
There are several benefits than an LLC provides its members. Some of these benefits are described in more detail below.
LLCs Require Less Paperwork and Documentation
Firstly, an LLC offers members the option of forming a legitimate business, without all of the paperwork that is required for a corporation. An LLC offers limited liability, similar to the way that corporations do; however, corporations require far more documentation.
LLCs Require Less Record Keeping
Part of the paperwork reduction that LLCs enjoy, in contrast to corporations, is the record-keeping of annual reports. Corporations must typically make annual reports and have a substantial amount of recordkeeping requirements. LLCs, on the other hand, do not have to keep extensive records or file any annual reports. LLCs also do not have to keep records of annual meetings and do not require minute books the way that corporations do.
LLC Tax Advantages
One of the greatest advantages to an LLC is that they offer a good number of tax advantages. First of all, the business itself is not responsible for taxes on company profits. Instead, the LLC members report their share of business profits and losses on their personal tax returns, similar to the way that taxes are reported for a general partnership, also known as “pass-through taxation.” What this typically means is a lower tax rate on company profits because personal tax rates are often lower for founders than corporate rates. Traditional corporations, on the other hand, are taxed twice on distributions to shareholders, both corporately and individually. The tax flexibility that LLCs offer is a huge advantage and an incentive for forming a Limited Liability Company.
LLCs Can Protect Personal Assets- Limited Personal Liability
A true benefit to forming an LLC is that the members’ personal assets are protected. This is because the LLC is divided from its members into legal terms. An LLC is able to limit your personal liability in the case in which you, an employee, or a business partner is accused of negligence; your own personal assets cannot typically be touched in such circumstances. In the case of traditional partnerships, your personal debts and your business-related debts are ultimately the same. An LLC is able to protect your personal assets within your business to create limited personal liability for all members.
LLCs Offer Ownership Flexibility
Another great benefit that LLCs offer is member flexibility. There is no limit on the number of members that a Limited Liability Company is able to have, and additional members are able to purchase equity within the company. Not only do LLCs offer pass-through taxation, but they are able to do so without restricting the number or even the type of members that a specific LLC may have. It’s important to remember that an LLC can pass-through losses and profits. For some, sharing in the loss of a company can actually be beneficial to reducing their personal tax liability.
LLCs Offer a Flexible Management Structure
Typical corporations are structured in a hierarchical way. For example, a corporation’s board of directors will inspect those who run the everyday business, as well as company policies, and the corporation’s shareholders must conduct annual elections for potential directors. This is not the case for Limited Liability Companies, however. In LLCs, the members are able to have greater flexibility in the way that they make decisions and in the way that their business is run overall. An LLC is typically a much more efficient structure to use for a small business or startup.
LLCs Offer Flexible Profit Distributions
In Limited Liability Companies, it is not required for members to distribute company profits equally, or through specific ownership percentages. If a certain member contributes more time, labor and money for the company, then he or she is able to receive a larger profit share. In the case of a corporation, company profits must be shared equally depending on the types and the number of shares that each member holds. The flexibility that LLCs offer in the way that profits are distributed through members makes it a desirable company structure for many. One important application here is the separation of ownership and profit distributions. One LLC member may own a controlling share of the company, but another may receive a majority of the profits. This type of structure can allow startup founders to retain control of a company while giving investors rights to larger portions of the profit distributions.
Benefits of a Corporation
Corporations Offer Limited Personal Liability
Similar to LLCs, corporations are able to provide their shareholders with limited liability protection. The shareholders of a corporation are able to protect their personal assets because the business is a separate entity. Both a Limited Liability Company and an Incorporated Company offer this benefit. Corporations typically have a wall of legal protection that is more difficult to “pierce” than that of an LLC. If you’re looking for the greatest amount of separation between personal and business assets or liabilities, a corporation is likely the best choice.
Corporations Tax Advantages
Forming a corporation also comes with having tax advantages, though these advantages are different from an LLC. Tax advantages for corporations include self-employment tax savings and the deductibility of expenses such as health insurance and life insurance. If you want to know more about the specific tax-related benefits that come with forming a corporation, please consult a tax advisor or an accountant in your state. These advantages can vary by state, and there are a handful of states that present very attractive tax environments for corporations. The best states to form a corporation include Delaware, Nevada, South Dakota, and Wyoming. California, New York, and New Jersey are often considered some of the worst states for corporations. For example, at the time of this article, the corporate tax rate in Delaware is 0%, while the corporate tax rate in New Jersey is 9%.
Corporations Have a Perpetual Existence
A corporation will not cease to exist if a business owner leaves the company, or passes away. A corporation will continue to exist and continue to do business, regardless of what happens to shareholders, managers, officers, of individual corporate directors. Corporations are known to be the most enduring legal business structure, as they continue to exist perpetually. This is a great benefit when it comes to avoiding any potential legal entanglements, that can prove to be troublesome within other types of businesses. For startups founders, this can be seen favorably by outside investors who to be sure the company can continue even if the founder were to leave.
Corporations Offer Retirement Plans
It is easier to establish retirement plans and retirement funds (such as 401 K) for corporations than it is for other business structures. It is important to know, however, that the taxation for corporations is generally quite complex, as different corporations will offer different tax advantages. The benefits that corporations are able to provide in terms of retirement plans may not be of the highest priority for certain businesses, for example.
Corporations Have Easier Access to Capital
With corporations, it is much easier to raise capital through the sale of stock. Additionally, banks are more likely to provide small business loans to incorporated businesses. Another benefit is that corporations have greater access to alternative sources of capital, which they can use to their advantage to pay off business debts. Corporations are seen more favorably by venture capital investors, specifically after the early rounds of funding are in place.
It is generally advised that you start off by forming a Limited Liability Company (LLC), as larger corporate structures can be more of a burden than a benefit, as they are more costly and more legally complex. A corporation has formal requirements that can be troublesome for small companies. When your company is ready to raise capital, you could then choose to convert your business into a corporation. This is a common scenario when companies are ready to raise significant rounds of investment.
Corporations offer many benefits as a business form; however, if you are a small or medium-sized business, then an LLC is probably a better option for you. While both an LLC and a corporation provide limited personal liability, with an LLC, members can take advantage of the benefits that a corporation is not able to offer in the same way. These benefits include a more flexible management structure, flexible profit distributions, less paperwork and documentation, and great tax benefits.
Disclaimer: This article is intended to help business owners make more informed decisions in regards to the topic; however, please contact an attorney for legal advice and an accountant for tax advice. Populus makes no representation as a legal advisor or tax advisor.