You've concluded it would be advantageous to operate your small business through an entity that limits the personal liability of all the owners-even if following this strategy involves a bit more paperwork, complexity and possible expense.
You've probably narrowed your choice of entity to either the tried and true corporation or the new and streamlined LLC. Which is better? There's no answer to this question that applies to every business. Nevertheless, some general principles may be helpful.
For the majority of small businesses, the relative simplicity and flexibility of the LLC makes it the better choice. This is especially true if your business will hold property, such as real estate, that?s likely to increase in value. That's because regular corporations (sometimes called C corporations) and their shareholders are subject to a double tax (both the corporation and the shareholders are taxed) on the increased value of the property when the property is sold or the corporation is liquidated. By contrast, LLC member-owners avoid this double taxation because the business's tax liabilities are passed through to them; the LLC itself does not pay a tax on its income.
But an LLC isn't always the best choice. Occasionally, other factors will be present that may tip the balance toward a corporation. Such factors include the following:
- You want to set up a single-member LLC but you live in a state which requires two or more members. Only two states now require that an LLC have two or more members. (Of course, if you live in one of these states and are married, you can easily comply with the LLC rules by including your spouse as an LLC member.) But if for any reason you can't - or don't want to meet this two-member rule, you'll need to incorporate to limit your personal liability. (Every state allows one-person corporations.)
- You'd like to provide extensive fringe benefits to owner-employees. Often, when you form a corporation, you expect to be both a shareholder (owner) and an employee. The corporation can, for example, hire you to serve as its chief executive officer and pay you a tax-deductible salary, which, from a tax standpoint, is far better than paying you dividends, which can't be deducted by the corporation as a business expense and therefore wind up being taxed twice (once at the corporate level and once at the personal level). But corporate employees (including employees of a C corporation who are also owners) don't just receive pay - most also receive fringe benefits. These benefits can include the payment of health insurance premiums and direct reimbursement of medical expenses. The corporation can deduct the cost of these benefits and they are not treated as taxable income to the employees. Having your own corporation pay for these fringe benefits and then deduct the cost as a business expense can be an attractive feature of doing business through a regular corporation. These opportunities for you to receive tax-favored fringe benefits are somewhat reduced if you do business as an LLC. Also, a regular corporation may be able to offer slightly better retirement benefits or options under a corporate retirement plan.
- You want to entice or keep key employees by offering stock options and stock bonus incentives. Simply put, LLCs don?t have stock; corporations do. While it's possible to reward an employee by offering a membership interest in an LLC, the process is awkward and likely to be less attractive to employees. Therefore, if you plan to offer ownership in your business as an employee incentive, it makes sense to incorporate rather than form an LLC.
