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Corporations Vs. LLCs, Risks and Benefits
Starting a business is an exciting endeavor, but it often comes with risks. If you’re just starting out on your journey of setting up a business, you may be overwhelmed by the number of decisions you need to make before you get your business up and running. And one of the first decisions you will have to make is choosing a business entity. A corporation and a limited liability company (LLC) are often the first two options that come to mind.
No matter which business entity you choose, each comes with its benefits and risks. If you want to make sure that your business is structured correctly, you need to consider both the advantages and disadvantages of setting up an LLC and incorporating your business. Our attorneys at Caleb Bland Law, PLLC, can provide you with the guidance you need to select the right entity that best meets your long-term goals.
What Is a Corporation and an LLC?
A corporation is a legal entity separate from its owners, who are the shareholders. It can own assets, incur liabilities, and has the ability to enter into contracts. Corporations are often chosen by larger businesses due to their structure, which supports scalability.
On the other hand, a limited liability company (LLC) blends elements of both partnerships and corporations. Owners of an LLC, known as members, benefit from limited liability while enjoying more operational flexibility. An LLC is particularly appealing to small to medium-sized businesses because it is easier to manage and offers various tax options.
Fact: According to the U.S. Small Business Administration, 96% of LLCs in the United States are considered small businesses with fewer than 500 employees.
Similarities Between Corporations and LLCs
Despite their many distinctions, corporations and LLCs share several similarities:
Limited liability protection: First, both entities provide limited liability protection. This means that the personal assets of owners are generally protected from business debts and legal claims. Whether you opt for a corporation or an LLC, you can rest assured that your personal finances won’t be intact.
The filing of formation documents: Second, both corporations and LLCs are required to file formation documents with the state. For corporations, these documents are typically called Articles of Incorporation. For LLCs, they are known as Articles of Organization.
Having established their common ground, let's move on to the distinct advantages and disadvantages of each structure.
Benefits of a Corporation
Many people mistakenly believe that a corporation is only for large companies with multiple international branches. In reality, anyone could benefit from incorporating their business, from small startups to large companies with considerable revenues. Here are some of the benefits of incorporating your business:
Business security and perpetuity: Unlike sole proprietorships or partnerships, a corporation can continue to exist even if its owners change or pass away. This perpetuity ensures that the business can survive and thrive beyond the involvement of its original founders.
Access to capital: Corporations can issue stock, which is an effective way to raise funds for expansion, research, or other business needs. This makes corporations particularly attractive to investors who are looking for equity stakes in promising ventures.
Tax-deductible expenses: Corporations enjoy the unparalleled benefit of tax-deductible expenses. This includes costs related to healthcare, retirement plans, and other employee benefits. These deductions help reduce the overall tax burden, allowing for more reinvestment in the business.
Easy ownership transfer: Corporations also facilitate easy transfer of ownership. Shares can be bought and sold without disrupting the business operations. This kind of liquidity is a significant advantage for shareholders who may want to exit their investment at some point.
Attractive to investors and employees: Being a corporation can make your business more attractive in the eyes of both investors and employees. Investors often prefer the clear structure and potential for returns that corporations offer, while high-caliber employees may be more inclined to join a corporation due to potential stock options and other benefits.
While the benefits are quite striking, it's equally important to consider the advantages of forming an LLC as this business entity offers numerous benefits as well.
Benefits of an LLC
Setting up an LLC offers a plethora of benefits. Otherwise, it wouldn’t be the most common type of business in the U.S. So, what are those benefits exactly?
Ease of formation: One of the primary benefits of an LLC is that setting up this type of business is a much simpler process compared to other structures. Creating an LLC usually requires less paperwork and lower filing fees compared to a corporation. This simplicity makes it an attractive option for new business owners who want to get started quickly.
Tax flexibility: By default, an LLC is taxed as a pass-through entity, meaning the income is reported on the members' personal tax returns. However, LLCs have the option to be taxed as a corporation or an S corporation, which can offer various tax advantages depending on the situation.
Less recordkeeping: Compared to corporations, LLCs come with fewer formalities. There are no mandated annual meetings or extensive documentation requirements. This ease of management allows business owners to focus more on growing their business rather than getting bogged down with administrative tasks.
Easy division of responsibilities and profits: LLCs are very flexible when it comes to dividing responsibilities and profits among members. Unlike corporations, where profit distribution is tied to share ownership, LLCs can allocate profits and management duties as they see fit. This flexibility is particularly beneficial for businesses with diverse ownership.
Fewer restrictions: LLCs also face fewer restrictions in terms of operations and decision-making processes. There are generally no stringent rules about the number of members, their residency status, or the types of businesses that can be conducted. This operational freedom makes LLCs a versatile choice for various types of enterprises.
While LLCs offer numerous advantages, it is essential to understand the potential downsides of each structure as well.
Risks of a Corporation and an LLC
If you’re smart about starting a new business or restructuring an existing one, you wouldn’t choose between a corporation and LLC based on the benefits alone. It’s also worth considering the potential downsides and risks associated with each entity. The risks of incorporating your business include:
Expensive to set up: One of the primary drawbacks of forming a corporation is the expense involved. The initial setup costs can be substantially higher than those for an LLC. These costs include state filing fees, legal fees, and ongoing expenses such as annual report fees and franchise taxes.
Extensive recordkeeping and paperwork: Incorporating your business is all about formalities. Those formalities include maintaining detailed records of board meetings, shareholder meetings, and corporate resolutions. This administrative burden can be time-consuming and often requires the assistance of professionals.
Double taxation: A well-known disadvantage of corporations is the issue of double taxation. Corporations are taxed on their earnings at the corporate level, and then shareholders are taxed again on any dividends received. This double layer of taxation can be a financial drawback for business owners.
The benefits of creating an LLC may seem endless. However, reading through the list of risks and potential downsides could easily make you change your mind about the right structure for your business.
Inability to raise venture capital: One of the limitations of an LLC is that you won’t be able to raise capital to grow your business as easily as a corporation. Venture capitalists and investors often prefer the structure and potential return on investment that comes with owning shares in a corporation. This limitation alone can hinder the growth potential of an LLC.
Difficulty when transferring ownership: Transferring ownership in an LLC can be more complicated compared to a corporation. While corporations allow for easy transfer of shares, transferring membership interests in an LLC often requires the approval of all members. This can create challenges when members wish to leave or sell their interests.
Income subject to self-employment taxes: Another drawback is that members of an LLC may be subject to self-employment taxes on their share of the profits. This includes Social Security and Medicare taxes, which can add up to a large amount.
If, after learning more about the risks and benefits of setting up an LLC and corporation, you still aren’t sure which type of entity is right for your business, you might need legal counsel from an attorney.
Let Us Help You Choose Between a Corporation and LLC
Your choice of a business entity will have a huge impact on many aspects of running your business. This includes how much you will pay in taxes, how you will raise money, how much paperwork you will deal with, and many more. Thus, choosing between a corporation and LLC—or any other business structure, for that matter—is something you shouldn’t take lightly.
Our attorneys at Caleb Bland Law, PLLC, can evaluate your current situation and learn more about your long-term goals to advise you on your options. We are based in Elizabethtown, Kentucky, but serve clients throughout the state, including Louisville, Radcliff, Brandenburg, Shepherdsville, Hodgenville, and surrounding areas. Take your first step forward to forming the business of your dreams by scheduling a free consultation with our team.