Incorporation versus Limited Liability Company
Incorporating has been around since the USA was founded, whereas Limited Liability Companies, LLCs, have only been around since 1979. The first State with an LLC was Wyoming in 1979. California has allowed LLCs since 1995 which is a relatively short time. Therefore, many laws for LLCs have not been reviewed by the Courts and many decisions are based upon corporation law in California.
If you are looking to start a domestic limited liability company and are wondering ‘What is a corporation business?’ or ‘What is an LLC?’ then read on to find out more.
What is an LLC?
An LLC is a hybrid between a corporation and a partnership. The LLC has the benefit of limited liability meaning that the owner’s liability is limited to their investment in the entity.
There are exceptions to limited liability such as piercing the corporate veil meaning that when the structure of the LLC is not followed, compliance with the rules is not followed, or the owners intentionally act such as fraud or assault, then the LLC assets are commingled with the individual owners.
In most cases, LLC liability is the same as a corporation.
An LLC is composed of members similar to shareholders. The LLC has a Manager or is managed by multiple managers or all members. The LLC has an operating agreement that details the rules and procedures for the actions of the LLC. Thus an LLC is much easier to manage than a corporation.
California LLCs have a gross revenue tax. This means that California LLCs may have a loss or little income and yet due to their revenues pay taxes. Therefore the LLC is easier to manage but you may pay taxes when you have revenue but are not making a lot of money.
There are limits to who may operate as an LLC. A doctor or lawyer cannot open an LLC in California. Their only option is a professional corporation. They are required to have a license and are not allowed to form an LLC in California.
What is an Operating Agreement?
An operating agreement is a document that customizes the rules and regulations for a limited liability company according to the needs of the members. It will detail what policies and procedures are to be undertaken and outlines the financial and functional decision-making policies. It is very similar to the articles of incorporation that govern corporate operations.
Although writing an operating agreement is not a mandatory requirement in all states, it is a very beneficial document. When setting up a limited liability company, time should be spent creating this document.
Once the document has been signed by each owner, known as a member, the document becomes a binding set of rules all those involved in the LLC must adhere to.
The agreement is drafted to allow owners to set a series of internal operations that are more suitable for their brand’s needs. In the absence of an operating agreement, the default set of rules applied are those of the state.
What is a Corporation Business?
Corporations have existed for hundreds of years. A corporation business is structurally more well-known. A corporation is owned by shareholders who elect directors. The directors manage major issues of the entity and appoint officers. Meaning you must control the Board of Directors to determine who can be an officer of the corporation.
Typical Officers of a corporation are a President or Chief Executive Officer, A Chief Financial Officer (CFO) or Treasurer, and a Secretary. A Secretary of a corporation is not the traditional secretary in an office. The Secretary of the Corporation drafts the minutes for the corporation, and the bylaws sign every stock certificate and notice meeting. Corporations that have attorneys typically have the lawyer act as Secretary of the Corporation.
What are Minutes?
Minutes are the actions of the corporation that detail who can act and what actions are taken to operate. When an entity is formed the first action of the corporation is to have an organizational meeting, which is the FIRST action of the corporation.
Even the first meeting requires notice to the necessary parties that a meeting will occur. Typically the first meeting will be attended by the incorporator, the shareholders, and the expected Directors. The meeting will discuss the filing of the articles of incorporation and approval by the California Secretary of State. The California incorporation number and date of filing will be the first minutes of the meeting.
Secondly, the bylaws will be adopted and approved by the Board of Directors. The Bylaws are the rules and regulations for the corporation. There are many rules in the Bylaws and it's a good idea to know what's included in the bylaws for your corporation. These can include but are not limited to:
- The quota to have a meeting.
- Who can vote?
- Who is an officer or director?
- What is each officer and their role?
- The duties and responsibilities of each officer.
- The requirements for notice for a meeting.
- Setting the date for an annual meeting.
- How to set a special meeting.
The next items in a corporation minutes are determining the first directors of the corporation and then the officers of the corporation with their titles. The minutes should include the bank where you will open your account and the accountant if you have an accountant.
You should also cover whether you want to make an S Election or not. An S corporation means the income and expenses of the corporation shareholders, in relation to their ownership interests, are passed through to each shareholder. This means if you own 30% of a corporation then 30% of the corporation revenues and 30% of the expenses will pass through to you in the form of a K-1 statement, The net profit or loss attributable to your 30% ownership will then be listed on your income taxes as the income or loss passes through to you individually.
An S Election has a short deadline to file, and requires all shareholders to consent in writing,
to the filing of a form 2553 with the Internal Revenue Service (IRS) and the IRS approval. To qualify as an S corporation you must be a resident alien or citizen of the United States.
Advantages of Incorporation versus Limited Liability Company
There are many advantages of incorporation versus Limited Liability Company. Here are some aspects to consider.
- No gross revenue tax in California.
- The only option if you're a professional.
- Many cases decided to determine the outcome for various situations.
- More well-known.
Advantages of Limited Liability Company versus Incorporation
- No minutes are necessary annually, just the operating agreement determines how actions are required.
- Can be a non-citizen of the USA or not immigrating to the USA (no requirement to be a resident alien of the USA).
- Your taxes-unless a one-member LLC-are automatically passed through to your individual tax return without any need for an S Election or approval requirements (unless you are a one-person LLC).
Do you Need an Employee Identification Number?
One of the big differences between an LLC and a corporation is the tax. One of the benefits of being a one-member LLC is that you don’t need to have an Employee Identification Number unless there are other forms of income.
If there are more than two members in an LLC, then you and the other members will need to have an Employee Identification Number. If you hire employees at the LLC, you too will need to apply for an EIN.
As a corporation, you will always need to have an Employee identification number.
If in doubt, speak to a tax accountant about what options you have.
Which form of business ownership is the most common in the United States?
The most common business entity in the US is a sole proprietorship. There are other options including a limited liability company, corporation, partnership, etc. You will need to see which type of business entity is most suitable for your business.
What do business owners consider when they select a business ownership structure?
There are several different options for choosing a business entity. You might want to consider a corporation, limited liability company, professional corporation, or non-profit among others. Some entities will not be an option and you will need to consider the advantages and disadvantages of each.
What is an operating agreement?
When forming a limited liability company you will need to produce an operating agreement. This forms the rules and regulations for your company. This document ensures that everyone knows what is expected of them.
There are numerous business structure options when you’re starting a business. Choosing whether you want to incorporate or set up a Limited Liability company can be one of the more challenging questions. There are advantages to both which is why you might want to learn about both structures and how to set them up before making the final decision.