So you want your own business. Or, you have been doing business under a certain name but have not yet incorporated. Often even the savviest entrepreneurs do not understand the basics of setting up a corporation. This article is a quick reference guide to some of the differences in protection, setup and maintenance of a corporation (C-Corp or S-Corp) and an LLC (Limited Liability Company).
1) Why to Incorporate?
While there are many reasons for incorporation, one main purpose for incorporating a business is to shield your personal assets from creditors or a judgment. However, beware that oftentimes when a corporation seeks to purchase assets, such as a corporate car for its employee, the bank that finances the purchase will ask for a personal guarantee. If you give a personal guarantee, then the corporate asset is no longer shielded by the “corporate veil.” This is true whether it is a C-Corp, and S-Corp or an LLC. The other main reason to incorporate is to obtain certain tax advantages. Every business owner should have a good Certified Public Accountant or tax attorney who can advise them on complex tax issues.
2) What is an S-Corp?
An S-Corp is a corporation that has taken one further step for different tax classification. In order to elect for S tax treatment, you must be an employee of the corporation. When considering whether to form an S-Corp, you should consult a Certified Public Accountant for advice. CPAs or attorneys specializing in tax work can best advise which tax treatment is best for your particular company.
3) What is an LLC and Why All the Hype?
An LLC, or Limited Liability Company, sometimes may offer even better protection from liability than a traditional C-Corp. First, an LLC avoids double taxation. For example, a C-Corp is taxed at corporate rates and then the owner who takes income from the corporation may then be taxed again on that same amount as income tax. Additionally, creditors who win a judgment against an LLC may only receive a Charge Order against distributions. Thus, after the LLC discloses its distributions (salaries, etc.), no distributions may remain that can be applied to the Charge Order. Therefore, in some cases, the creditor holding the Charge Order against the LLC may receive little or no payment on its judgment. Avoiding double taxation and potentially decreasing the risk that the corporate veil would be pierced are both strong reasons to consider if an LLC is the right choice for your business.
4) Is Formation of a C-Corp or an S-Corp or an LLC Difficult, and How Much Does It Cost?
Both a C-Corp (or S-Corp) and an LLC are relatively simple to form. An attorney can help you form any type of corporation. A C-Corp (you must do this step even if you later want to elect to become an S-Corp) is formed by preparing and filing the Articles of Incorporation with the Secretary of State and paying a fee. Government filing fees range from approximately $100 – $300, depending on whether you file online or off-line, expedited or non-expedited, and vary from state to state. Thereafter, corporate minutes, bylaws and other documents are drawn up to spell out how the corporation will operate. At this point, it is also a good idea to open a separate bank account for the corporation. To do this, you will need a tax I.D. number. This number can be applied for online or with the help of your accountant or lawyer. You should put initial capital (traditionally $ 1,000) or more into the new account and give a copy of the check to your lawyer to be stored with the corporate records as proof of initial capital. Next, appoint a registered agent for your new corporation. This may be, but does not have to be, your attorney. Last, your attorney must prepare shareholder minutes each year to keep the corporation up-to-date.
Formation of an LLC is a similar process. Instead of Articles of Incorporation, you will need your attorney to prepare and file Articles of Organization and pay a fee. Government fees to form an LLC are traditionally a bit higher than those of a C-Corp and vary from state to state (approximately $500 in Illinois). An LLC does not have “shareholders” as a C-Corp, but instead has “members.” Unlike a corporation, trusts cannot be shareholders, but may be Members of an LLC. Additionally, LLC’s have less annual corporate formalities.
5) Do I Need A Lawyer?
Many sites online provide guidance and forms for “Do-It-Yourself” incorporation and formation of your business. Many of these services are low cost and will help you get incorporated or help you form your LLC. However, an attorney can help you talk through which corporate structure is most beneficial to your type of business and most aligned with your goals and vision for the future of the company. Importantly, an attorney can help you manage the maintenance of the correct forms and filings so that the corporate veil will be preserved in case of a lawsuit against the corporation. More factors go into a court’s decision as to whether to pierce the corporate veil and allow a successful litigant to pursue an owner’s personal assets, and most courts disfavor piercing the corporate veil, but if the corporation is not kept up to date, a court will consider the same in making its decision. While an attorney is not mandatory, an attorney is well-versed in the law and can handle the details of your corporation while you work on growing your business.