Many small business people, when they establish a business entity, wonder if setting up an LLC is the best choice. In most situations, you will find that setting up yourself, initially, as an LLC is a wise business decision, as you can always re-establish yourself, if needed, as a corporation. The following information shows why an LLC is usually the best choice when figuring out whether to incorporate or to set up a limited liability company.
Why an LLC is Frequently a Better Option
Before we explore why an LLC is often a good entity to select for start-ups, we have to review why both a corporation and LLC are good for a business legally. Both types of entities protect an owner’s assets and therefore add a layer of protection against personal liability.
However, with that being said, setting up an LLC versus a corporation, is simply easier, as less time and paperwork are involved. While you may attract more venture capital to a corporation, you can still set yourself up as a Delaware-based LLC and often have the same effect. Remember that when you set up an LLC, you must follow the guidelines of the state in which you plan to base your LLC.
While some states have you fill out forms, for instance, for the Articles of Organization, other states require that you file the paperwork with the Secretary of State. In some states, you need to give public notice that you are creating an LLC. This is usually done by posting the notice in a newspaper.
Setting Up an LLC is Less Time-consuming and Easier
Once you file your Articles of Organization or fill out a form for your Articles, the business is generally formed. Incorporating a business is far more detailed and formal – something that may be hard to initiate if you are just beginning a business.
While drafting an operating agreement is not necessary to form an LLC, you should still create one to define owner responsibilities and avoid internal disputes and conflicts. If you don’t establish the agreement, your LLC will be governed by the default rules outlined in a state’s statutes.
It just makes good sense, then, to draft an operating agreement, as it sets forth your obligations as an owner and can detail your company’s capital structure, how profits will be allocated, and what will happen if you choose to buy out a member. Provisions can also be made in case a member quits the company.
What Works Best Tax-wise
When reviewing an LLC vs Inc. status, the LLC offers more flexibility when it comes to taxation. This type of adaptability allows you, as an LLC owner, to report LLC earnings on your personal income tax return. Therefore, you avoid problems with double taxation, which can happen when you incorporate – not really good if you operate a fledgling business. However, establishing yourself as an S corporation allows you to get pass double taxation too.
Basically, an LLC will never pay any type of business tax. That makes it easy to rectify your business costs and pay your taxes. Therefore, an LLC member pays taxes themselves on the company’s earnings. The owner reports the business’s profits and losses on his or her personal tax return. LLCs are designed so owners can take responsibility for the company’s taxes on their own returns.
However, that does not mean that LLCs, when you consider incorporation vs. LLC, do not have some drawbacks. For example, LLC members still have to pay self-employment taxes. Also, the LLC can be dissolved if the LLC owner does not report the business’s filing on time or a member death or withdrawal occurs. Again, some of these provisions should be set forth in the LLC’s operating agreement.
Also, as an owner, transferring at least 50% of an LLC’s profits or interest within a year’s time will lead to a technical termination of the business. The law looks at this type of transfer as a tax-free contribution to a new LLC.
Because each LLC must operate according to the statutes of the state where it is formed, you may run across some uncertainties if you have LLCs in multiple states. Therefore, make sure you understand the individual laws if you choose to go this route when establishing an LLC.
Benefits of Establishing a Corporation
It is true. An LLC is simple to establish. Therefore, an LLC business set-up ranks as a major benefit when forming an LLC vs. Inc. Nevertheless, despite some formation complexities, a corporation does offer, even for start-ups, some significant advantages. For example, you can incorporate your business as an S corporation, and can establish your business as a pass-through entity, thereby avoiding the dreaded double taxation of a traditional C corporation.
While profits pass through LLC members, corporation profits and losses pass to the shareholder, who reports taxes on their individual tax return. If certain regulations are met, S corporation shareholders also receive tax-free dividends.
A C corporation also comes with certain advantages. For example, shares of stock may be sold if you need to raise capital for expansion. However, keeping those benefits in mind, you also have to deal with a great deal more paperwork and complications. Not only do you have to file a large amount of documentation, you have to elect a board of directors, adopt company bylaws, and set up annual meetings. All these activities also come with their own formalities.
If you are a start-up business, again, it usually is best to begin as an LLC. When you consider an LLV vs. Inc., you will find each type of entity has certain nuances. Find out what works best for you by consulting with a business lawyer before you establish your business. In most cases, forming an LLC will save you both time and money when you are just beginning.