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Corporation or LLC?

We are often asked by those wanting to start a business whether they should use a corporation or limited liability company format. Typically, the answer is “it depends”. There are many matters that must be considered. The purpose of this article is to consider the major differences between the two types of business entities.

Corporations and Limited Liability Companies (“LLCs”) are preferred business structures because they both offer protection to their owners from liability from the company’s debt or obligations. Subject to few exceptions, the personal assets of the owners of corporations and LLCs are usually shielded from the liabilities of such company in which they have ownership.

A corporation may elect certain tax status under the Internal Revenue Code to allow the profits and losses of the corporation to “pass through” to its owners and be reported on the owners’ personal tax returns. However, to qualify for the “S” tax status, such corporations may only be owned by U.S. resident individuals and the corporation must have fewer than 100 shareholders. Also, when distributing profits, the S corporation must make distributions among all shareholders according to the ratio of stock ownership, regardless if the shareholders desire for it to be distributed differently. S corporations are operated the same as a regular corporations – the shareholders elect directors who make policy decisions for the corporation and who elect the officers of the corporation who take care of the day to day operations.

LLCs provide the same tax benefits as S corporations as “pass- through” entities. However, LLCs offer greater flexibility in ownership and ease of operations. There are no restrictions on the ownership of an LLC. An LLC can be managed by the members, or the members may appoint a manager or managers to operate the company. The members can divide profits as they desire, regardless of their ownership percentages. The tax disadvantage of an LLC is that the entire net income of the business is subject to self employment tax. In an S corporation, only the salary paid to the employee-owner is subject to such tax.

One should also consider that LLCs are a relatively new form of entity and the corporate structure is more well known. The cost of creating the entities and Florida’s annual fees are very similar.

Notwithstanding, anyone considering whether to use a corporation or LLC should meet with an attorney who has experience in such matters and with a Certified Public Accountant to fully understand the tax ramifications before deciding.