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Corporation vrs LLC

” C ” Corporations

A corporation is an independent legal entity owned by shareholders. This means that the corporation itself, not the shareholders that own it, is held legally liable for the actions and debts incurred by the business.Corporations are more complex than other business structures. Corporations tends to have costly administrative fees and complex tax and legal requirements. Because of these issues, corporations and generally suggested for established, larger companies with multiple employees.For businesses in that position, corporations offer the ability to sell ownership shares in the business through stock offerings. Going public through an initial public offering (IPO) is a major selling point in attracting investment capital and high quality employees.

Forming a Corporation

A corporation is formed under the laws of the state in which it is registered. To form a corporation you’ll need to establish your business name. For corporations, your legal name is the one you register with your state government. If you chose to operate under a name different than the officially registered name, you’ll most likely have to file a fictitious name (also known as an assumed name, trade name, or DBA name, short for “doing business as”). State laws vary, but generally corporations must include a corporate designation (Corporation, Incorporated, Limited) at the end of the business name.

To register your business as a corporation, you will need to file certain documents, typically articles of incorporation, with your state’s Secretary of State office. Some states require corporations to establish directors and issue stock certificates to initial shareholders in the registration process. If you are hiring employees, read more about federal and state regulations for employers.

How Corporations are Taxed

Most businesses will need to register with the IRS and state and local revenue agencies, and receive a tax ID number or permit.

Corporations are required to pay federal, state, and in some cases, local taxes. Most businesses must register with the IRS and state and local revenue agencies, and receive a tax ID number or permit.

When you form a corporation, you create a separate tax-paying entity. Regular corporations are called “C corporations” because Subchapter C of Chapter 1 of the Internal Revenue Code is where you find general tax rules affecting corporations and their shareholders.

Unlike sole proprietors and partnerships, corporations pay income tax on their profits. In some cases, corporations are taxed twice – first, when the company makes a profit, and again when dividends are paid to shareholders on their personal tax returns.

Shareholders who are also employees pay income tax on their wages. The corporation and the employee each pay one half of the Social Security and Medicare taxes, but this is usually a deductible business expense.

  • Limited Liability. When it comes to taking responsibility for business debts and actions of a corporation, shareholders’ personal assets are protected. Shareholders can generally only be held accountable for their investment in stock of the company.
  • Ability to Generate Capital. Corporations have an advantage when it comes to raising capital for their business – the ability to raise funds through the sale of stock.
  • Corporate Tax Treatment. Corporations file taxes separately from their owners. Owners of a corporation only pay taxes on corporate profits paid to them in the form of salaries, bonuses, and dividends, while any additional profits are awarded a corporate tax rate, which is usually lower than a personal income tax rate.
  • Attractive to Potential Employees. Corporations are generally able to attract and hire high quality and motivated employees because they offer competitive benefits and the potential for partial ownership through stock options.

 

Disadvantages of a Corporation

  • Time and Money. Corporations are costly and time consuming ventures to start and operate. Incorporating requires start-up, operating, and tax costs that are not required of most other structures.
  • Double Taxing. In some cases, corporations are taxed twice – first, when the company makes a profit, and again when dividends are paid to shareholders.
  • Additional Paperwork. Because corporations are highly regulated by federal, state, and in some cases local agencies, there are increased paperwork and recordkeeping burdens associated with this entity.

 

Limited Liability Company ( LLC )

The “owners” of an LLC are referred to as “members.” Depending on the state, the members can consist of a single individual (one owner), two or more individuals, corporations, other LLCs, and even other entities.

Unlike shareholders in a corporation, LLCs are not taxed as a separate business entity. Instead, all profits and losses are “passed through” the business to each member of the LLC. LLC members report profits and losses on their personal federal tax returns, just like the owners of a partnership would.

Forming an LLC

While each state has slight variations to forming an LLC, they all adhere to some general principles:

  • Choose a Business Name. There are 3 rules that your LLC name needs to follow: (1) it must be different from an existing LLC in your state, (2) it must indicate that it’s an LLC (such as “LLC” or Limited Company”) and (3) it must not include words restricted by your state (such as “bank” and insurance”). Your business name is automatically registered with your state when you register your business, so you do not have to go through a separate process.
  • File the Articles of Organization. The “articles of organization” is a simple document that legitimizes your LLC and includes information like your business name, address, and the names of its members. The form is provided by and filed with your state’s LLC office. For most states, you file with the Secretary of State.
  • Create an Operating Agreement. Operating agreements are not required by most states and are not filed at your state office. However, an operating agreement is highly recommended for multi-member LLCs because it structures your LLC’s finances and organization, and provides rules and regulations for smooth operation. Percentage of interests, allocation of profits and losses, member’s rights and responsibilities, and other provisions are usually included here.

 

Filing Taxes

In the eyes of the federal government, an LLC is not a separate tax entity, and therefore the business itself is not taxed. Instead, all federal income taxes are passed on to the members of the LLC and are paid through their personal income tax. While the federal government does not tax income on an LLC, some states do, so check with your state’s income tax agency.

Since the federal government does not recognize LLC as a business entity for taxation purposes, all LLCs must file as a corporation, partnership, or sole proprietorship. Certain LLCs are automatically classified and taxed as a corporation by federal tax law.

Advantages of an LLC

  • Limited Liability. Members are protected from personally liability for business decisions or actions of the LLC. This means that if the LLC incurs debt or is sued, members are not required to satisfy the claims with their personal assets. This is similar to the liability protections afforded to shareholders of a corporation. Keep in mind that limited liability means “limited” liability – members are not necessarily shielded from their or their employees’ tort actions, such as accidents.
  • Less Recordkeeping. An LLC’s operational ease is one of its greatest advantages. Compared to an S-Corporation, there is less registration paperwork and there are smaller start-up costs.
  • Sharing of Profits. There are also fewer restrictions on profit-sharing within an LLC, as members distribute profits as they see fit. Members might contribute different proportions of capital and sweat-equity. Consequently, it’s up to the members themselves to decide who has earned what percentage of the profits or losses.

 

Disadvantages of an LLC

  • Limited Life. In many states, when a member leaves an LLC, the business is dissolved and the members must fulfill all remaining legal and business obligations to close the business out. The remaining members can decide if they want to start a new LLC, or part ways. However, you can include provisions in your operating agreement to prolong the life of the LLC, should a member decide to leave the business.
  • Self-Employment Taxes.Members of an LLC are considered self-employed and must pay the self-employment tax contributions towards Medicare and social security. The entire net income of the LLC is subject to this tax.

 

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