If you are thinking about starting a new company, chances are, you have probably wondered whether you should form an LLC or a Corporation. It doesn’t help that the differences are sometimes confusing, when considering that taxation, accounting, management, and operational issues can influence which entity is more favorable. We’ve put an overview together to help give you some of the major factors that new business owners consider when making the decision. This is not a complete list of every matter that should factor in your decision, and the decision for your business could depend on other circumstances not mentioned below. With all that said, here’s an overview of the differences:
Separation Between Ownership and Management
One of the big differences between an LLC and a Corporation are the individuals who will be running the company, and the fact that they are not necessarily the ones who will be owning the company. In a Corporation, the company is run on a day-to-day basis by a CEO/President, CFO/Treasurer, and Secretary. These positions are called “officer” positions. The officers of the company are subject to the control of and must report to a Board of Directors, who are responsible for the management of the Company as a whole. None of the officers or directors necessarily need to own the company, or be considered “shareholders.” In this respect, a corporation distinguishes between its owners (shareholders) and its managers (directors) and its operational employees (officers).
In an LLC, the company is run by “Members” who are its owners. There is no distinction between ownership and management in the LLC context. This means that LLCs are often used for smaller companies, where there are a few owners and the parties know each other and work together personally. There is no formal method by which shareholders elect directors who in turn elect officers. The people who run the company are the same as the owners. That being said, an LLC can determine whether it wants to be managed by the members individually or by a managing member, or managing board. An LLC is flexible enough to allow it to be operated in a manner similar to a corporation, by electing officers and appointing committee members, and other duties.
Another big area of difference between an LLC in the Corporation have to do with how accounting takes place. In a corporation, the corporation is considered its own entity, and there is a ledger for the corporation itself, so that the corporation can pay taxes on its income and deduct expenses at the end of the business year. In an LLC, on the other hand, the entity is not taxed individually. Taxes are paid by the individual members, who deduct their share of the LLC’s expenses. This is called “flow-through” or “pass-through” taxation. It avoids a situation where the shareholder must have the corporation pay taxes and then pay additional taxes on the income distributed by the Corporation to the shareholder.
Is your business thinking of hiring employees immediately? If your business is set up as a Corporation, the services you provide to your company was generally be through employee wages, meaning that you will be an employee of your own company, and will have to receive W-2 wages. This will also involve notifying the California EDD of your status and as an employee, and withholding monthly or quarterly payroll deposits at the state and federal level. An LLC, on the other hand does not operate in this fashion. LLC members can perform services for the LLC without simultaneously being employees. Because all incoming distributions are passed through to the owners, owners withhold their wages as self-employment wages, and withhold self-employment tax deposits on a quarterly basis. Going through payroll is not required.
Finally, perhaps one of the more important elements of deciding whether to start your company as an LLC or corporation involve state taxes. In California, a LLC has to pay a separate tax that corporations do not pay. In addition, the Franchise Board minimum $800 payment for new entities is waived in the first year for corporations but must be paid in the first year for LLCs. In this respect, in California, and LLC is more expensive to operate from an administrative standpoint then a corporation.
Many small businesses, startups, entertainment companies, real estate companies, and other types of businesses often select to be an S Corporation in California. An S Corp has the benefit of avoiding double layers of taxes, like an LLC. However, it is not subject to the LLC tax, and other administrative expenses of an LLC in California. It can be an easy and effective way for businesses to reduce their tax expenses, and minimize other governmental obligations. That being said, an S Corp is subject to a 1.5% tax by the Franchise Board, and cannot be owned by another entity. It must be owned by an individual.
Getting Legal Help
If you’re thinking of starting a new business entity and are not sure which is the right option for you, we suggest contacting an attorney to discuss with you the benefits and disadvantages of forming an LLC, C Corp or S Corp. Speaking to a business attorney can help you get guidance on the unique situation and circumstances of your particular business, and avoid a situation where you’re paying unnecessary fees, expenses, or taxes.
AXIS Legal Counsel’s Business and Corporations Practice provides legal advice to numerous businesses with a variety of legal matters, including business formations, contracts, deals, and transactions, business administration, corporate governance, operations, risk management / insurance, labor/employment matters, intellectual property, healthcare, crisis management, directors/officers, private/data security, technology, statutory/legal compliance, and business litigation. AXIS represents businesses, corporations, LLCs, LLPS, partnerships, and startups in need of a corporate lawyer, for business legal matters as well as business litigation, such as disagreements, non-solicit agreements, non-competes, trade secrets, and other disputes with businesses. We are also experienced in providing assistance to business clients concerning business contracts, corporate formation matters, contracts and transactions, business litigation, business legal advice for Corporations, LLPs, LLCs, Partnerships, Small Business, Startups, and others involving corporate law.
If you are seeking a business lawyer, or for information on retaining AXIS Legal Counsel to represent your business in connection with any legal matter, contact firstname.lastname@example.org or call (213) 403-0130 for a confidential consultation. Axis’ managing attorney Rabeh M. A. Soofi is ranked as one of the “Top Women Lawyers of Southern California” by SuperLawyers Rising Stars, and is a Los Angeles Business Lawyer representing businesses and start-ups throughout Los Angeles and California.
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