Should I Use a Corporation or LLC for My Business
In this article, I will use the word "entity" to refer to both a corporation
and an LLC. Both are separate legal entities and both have a number of
similarities.
First, an entity is a separate being that must be treated like a separate
person. The owner should not inter-mingle his own funds with those
of the entity even though he is the sole owner. There must
be a distinct separation between them.
Second, the entity and its owners must always act like a legal entity
exists in order to get the advantages of it. In signing checks and
purchase receipts, you must use your corporate or LLC title and be
sure that
the entity is the one listed as making the transaction. The
individual is merely the employee or agent of the entity and can
be held individually liable if he does not act properly.
FORMATION
In forming a corporation or an LLC, Articles of Incorporation or Articles of
Organization will need to be filed with the La Secretary of State. These
articles state the basic facts about the new entity and are the basis for
the Secretary of State to issue a charter. The charter is like a birth
certificate for the new entity.
In creating any legal entity, you must name a Registered Agent. Since a
corporation or LLC is no more than a thought in our minds, if it is sued,
there must be a person available who can actually be served with the suit
records. This person is called the Registered Agent. He must be an adult
and have an actual address within the State of Louisiana where he can be
found to give him the legal papers. There are some companies that exist for
the sole purpose of serving a registered agents, such as IT Corporation,
which is a nationwide company.
If a company is from out of state, it must register with the Secretary of
State and must name a person or company that is located within the State of
Louisiana to serve as its registered agent. The corporations that only do
work as registered agents normally service these companies from other states.
TAXATION OF CORPORATIONS
All corporations are basically the same in that they are created under state
laws of the state of their domicile. Once created, there are two basic ways
in which they can be taxed. These two methods are referenced according to the
section of the Internal Revenue Code that sets out the rules for them, namely
Sub-Chapter C and Sub-Chapter S.
"C" CORPORATIONS
A C corporation is one that is taxed as a normal or regular corporation without
any special elections. The net income is first taxed at 15% for the first
$50,000 of net income, then the rates go up. You can see the full range of rates
in another page on this site.
In computing the net income of the corporation, you take the total gross revenue
less the business expenses. Expense can include a salary for the owner to the
extent that he performs services and does work for the corporation. However,
any distributions of profits is considered to be a dividend and is not an
allowable expense in determining net income. In essence, a dividend is money
that has already been taxed at the corporate level and will be taxes again
when the shareholder receives it.
There is another page on this site relating to employees vs independent
contractors. In that subject, many small employers try to call their workers
independent contractors so that they don't pay payroll taxes on their earnings.
However, if the people are really employees, then they are exposing themselves
to extra taxes, penalties and interest if the IRS decides to audit them.
"S" CORPORATIONS
In an attempt to allow small companies to get the advantages of incorporating
but yet still allow only one level of taxation, Congress created the Sub-
Chapter S corporations. Under this election, the corporation does not pay
any taxes at the corporate level but the net income or net loss is "passed
down" to the shareholders and is tax in their returns--regardless of whether
there was any actual cash passed along to the shareholders or not. Many times,
corporations will need to retain their cash for inventories, expansion, etc,
so there may not be any cash given to the shareholder. However, he is still
subject to taxation on the income.
In both the C corp and S corp situations, the corporation is still required to
maintain good books of account and to file corporate income tax returns. In the
S corp, the return includes an extra schedule that is to be given to the
shareholder to tell him how much is to be included in his own personal return
for the year.
LIMITED LIABILITY COMPANIES
In recent years, a new breed of legal entity has shown up around the country
that is a hybrid between a partnership and a corporation--namely the Limited
Liability Company or LLC.
The LLC is formed by filing papers with the Secretary of State in a manner
very similar to forming a corporation and having a registered agent. The
primary difference relates to its ability to make elections as to how it
will be taxed.
TAXATION OF LLCs
If you create an LLC and do nothing about making an election, then an LLC
with only 1 member will be disregarded for tax purposes and the owner will
report all of his income on his personal return as though he were a sole
proprietor. If a multiple member LLC is formed without making an election,
then the default is that it will be taxed as a partnership with the LLC
keeping all of the records and filing a return but providing the partners
with a schedule showing the amount of income/loss that is allocable to them
each year.
In addition to the defaults allowed by the IRS, an LLC can make an election
to be taxed as a corporation. In doing so, it is just a matter of "checking
the box" on the ID application filed with the IRS and filing a form 8832
with the IRS in Philadelphia. Although I won't go into it now, suffice it
to say that every situation is different and there are some that are best
to be taxed as a corporation so that alternative is available.
Be sure to remember that under any of the above scenarios, the legal entity
must keep good records to support the income tax return that will be filed.
In no case should the owner attempt to operate his business "out of his
pocket" without keeping good records. The legal entity should always have
a checking account of its own and all revenues should be deposited and all
expenses should be paid out of the account by check. Personal deposits and
personal expenses should not be run through that account and the owner should
have his own personal account for such personal transactions.
If you want to talk about your situation, please call me at:
Marvin E. Owen
Attorney-CPA
3036 Brakley Drive
Baton Rouge, La 70816
ph 225-292-0099
e-mail marvin@intersurf.com
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