Corporations & LLCs

Companies and firms are under an alphabet soup of different entity structures, such as Inc., LLP, LLC, PC, LP, and others. These all create a legally separate business entity, shielding owners from personal liability when formed and maintained properly, and that is the most important reason to choose an entity. Most business owners find the S-Corporation (S-Corp) or the Limited Liability Company (LLC) ideal. But whatever you choose, and especially if you have partners or investors, ensure it is drafted and formed properly.

Corporation (S-Corp)

Corporations may be a C-Corporation (C-Corp) or an S-Corporation (S-Corp). The C-Corp has extensive filing and maintenance requirements. The S-Corp is easier to maintain, being designed for smaller businesses, but is also limited in ownership to 100 or fewer US Citizens or Residents. The C-Corp has "double taxation" meaning it has a corporate and personal income tax, while you do not worry about two taxes with an S-Corp. Both types are "corporations" for purposes of federal civil procedure, meaning the law treats them that way. It is usually best to start with an S-Corp when forming a corporation, and convert it to a C-Corp if and when it becomes necessary to do so.

Limited Liability Company (LLC)

The Limited Liability Company (LLC) is a newer form of entity that has only existed since 1977, and has grown in popularity over the years such that today it is the most common choice for new startups. While the LLC is a separate legal entity, it is not legally a "corporation" for purposes of federal civil procedure. The LLC is very flexible for tax purposes as it may be treated as a "sole proprietorship" if it is just you, a "partnership" if you have partners, or even an S-Corp or C-Corp when the situation makes sense. There is little restriction on ownership of LLCs as they may be owned by corporations and, in many cases, foreign citizens as well.

Which One is Better?

There is no correct entity choice for all cases. One entity may have an edge for some businesses, whereas for others it may matter very little. Consider what your business will be and what its goals are before making a selection. Is it just you or are there partners? Will there be any investors or startup capital involved? If there will be investors, is there an exit strategy? Does the business own any real estate, or is it going to be involved in real estate investing? Are you or one of your partners going to be working for the business and being paid an employee salary? We would like to get to know your business, and also your partnership structure, as we navigate the process with you.

Both the S-Corp and the LLC offer personal liability protection for its business owners. This means that you, the owner, cannot be held personally accountable for the obligations of the business, assuming you operate it under normal circumstances and do not commingle personal assets with the business. These obligations include things such as debts the business may have and lawsuits directed at the business. In short, both the S-Corp and the LLC are among the cheapest pieces of insurance you can buy as an owner to protect yourself. With few exceptions, such as perhaps a child's lemonade stand, you should structure your business as an entity.

The Formation Process

The formation process is usually straightforward and very fast to do once you have chosen your preferred entity and are ready to proceed. The following is a rough outline of the steps that are taken in the process.

1. Choose a Business Name. The name must be unique and cannot be confusingly similar to an already existing Corporation or LLC.
2. Choose a Registered Agent. Anyone 18 years or older that resides in the state of formation may be the agent. Usually it is an owner or a friend, but a separate service may be used.
3. Submit Articles of Organization. Sometimes called Articles of Incorporation or Articles of Formation, these must be submitted with state fees.
4. Apply for Taxpayer ID. A taxpayer identification number for the newly formed business must be obtained from the IRS to be used in future filings.
5. Develop an Operating Agreement (or Bylaws). This is kept internally and usually not filed with the state. But it is needed when opening new accounts, involving investors, and adding or removing co-owners. It should be drafted carefully.
6. Comply with Ongoing Requirements. While not a step to formation, once the entity is formed, it is important to maintain it properly so that personal liability protection is preserved.

The Operating Agreement (or Bylaws) in particular is important when forming an S-Corp, an LLC, or almost any entity. It governs the way business affairs are handled internally and, perhaps most significantly, it serves as the partnership agreement when there are two or more owners of the business. Courts and arbitrators look to the Operating Agreement for resolving disputes, because it governs internal disputes to the extent it is consistent with the law. Drafting it properly while the business is still young, with all parties' interests in mind, is critical.

After formation, the S-Corp or LLC must be properly maintained. This includes filings, such as tax returns, and other items governing the Operating Agreement. In maintaining the S-Corp or LLC, it is equally important that you treat it as a separate entity. This means you should never commingle personal accounts or assets with those owned by the business. Business owners that fail to keep the entity separate are sometimes found guilty of "piercing the corporate veil," meaning that they can be held personally liable for business debts and actions.