LLC vs. INC vs. IRS

Transcript

RICHARD BOOTH: Because of the tax benefits, LLCs are the first form of business that most new businesses should consider.

ELIOT WAGONHEIM: Money flowing into the company is treated differently depending upon what kind of company it is.

RICHARD BOOTH: With an LLC, you can take advantage of the losses in the early years if the business is expected to have losses. That can be a good thing because the losses can be taken personally on the individual's tax returns and they can be used in effect to shelter other income.

EDWARD JACOBSON: In a C corporation, those losses will be trapped at the corporate level and you will get no personal benefit from those losses.

RICHARD BOOTH: Now the problem with the corporation is that you have to pay an annual tax, which can get a bit expensive, $200 or $300 even for a corporation that does not even make any money.

The one thing to consider is that you can never go back from being a corporation to being an LLC. It is very easy to turn an LLC into a corporation if you need to do so for purposes of raising money. But from the tax point of view, it is a one-way street. You cannot go from being a corporation to being an LLC without adverse tax consequences that you really would not have to suffer if you simply started out with the LLC form.

ELIOT WAGONHEIM: And that is why it is important not only to seek the advice of a business attorney as to what type of company to form, but also seek the advice of an accountant as to what the different tax advantages and disadvantages are.

File Notes

LLC PROS AND CONS

Advantages of LLCs

The LLC is generally considered advantageous for small businesses because it combines the limited personal liability feature of a corporation with the tax advantage of a partnership or sole proprietorship. Profits and losses can be passed through the company to its members, or the LLC can elect to be taxed like a corporation. LLCs do not have stock and are not required to observe corporate formalities. Owners are called members, and the LLC is managed by these members or by appointed managers.

Disadvantages of LLCs

This is a very popular choice for small businesses, but it's not for everyone. Perhaps the biggest drawback to an LLC is that venture capitalists hate 'em. As the chart above shows, they can't get the preferential treatment that corporations can give them through preferred stock. That's a big bummer if you dream of going public someday.

In some scenarios, the tax consequences of LLC ownership are less than favorable. But you'll need to see an accountant to figure all that out. In other words, when it comes to IRS regulations, don't try this at home!

CORPORATION PROS AND CONS

A corporation chartered by the state in which it's headquartered is considered by law to be a unique entity, separate and apart from those who own it. A corporation can be taxed, it can be sued, and it can enter into contractual agreements. The owners of a corporation are its shareholders. The shareholders elect a board of directors to oversee the major policies and decisions. The corporation has a life of its own and does not dissolve when ownership changes.

Advantages of a Corporation

If you decide to incorporate, you'll get the following benefits:

  • Shareholders have limited liability for the corporation's debts or judgments against the corporations
  • Generally, shareholders can only be held accountable for their investment in stock of the company. (But don't forget that officers can be held personally liable for their own actions, like the failure to withhold and pay employment taxes.)
  • Corporations can raise additional funds through the sale of stock
  • A corporation may deduct the cost of benefits it provides to officers and employees
  • Can elect S corporation status if certain requirements are met. This election enables company to be taxed similar to a partnership

Disadvantages of a Corporation

  • The process of incorporation requires more time and money than other forms of organization
  • Corporations are monitored by federal, state and some local agencies, and as a result may have more paperwork to comply with regulations
  • Incorporating may result in higher overall taxes. Dividends paid to shareholders are not deductible from business income; thus it can be taxed twice

As Professor Richard Booth explained in this video, a corporation is a complex business structure with more startup costs than many other forms. A corporation is a legal entity separate from its owners, who own shares of stock in the company. It can be created for profit or nonprofit purposes, and may be subject to increased licensing fees and more government regulation than other forms. Profits are taxed both at the corporate level and again when distributed to shareholders. Shareholders are not personally liable for corporate obligations unless corporate formalities have not been observed. Observing such formalities provides evidence that the corporation is a separate legal entity from its shareholders. Failure to do so may open up the shareholders to liability of the corporation's debts.