It is quite difficult to confuse a Limited Liability Company (LLC) with a C-corporation. The two have many similarities and yet stark differences. If used effectively the LLC can potentially combine the benefit of a C-corporation with the benefit of a S-corporation. The result is a hybrid incorporation option that can be beneficial to an individual, a group of start up business investors, or a real estate investment group.
Difference #1: Uncle Sam’s Share
The main difference between LLCs and C-corporations is the way in which the business will be taxed. The profits of a C-corporation are taxed prior to distributing the profits to the business’ shareholders. Once the company has allocated the profits to the shareholders, taxes must again be taxed at the individual level or however the ownership is held.
An LLC that has been set-up as a partnership for tax purposes has pass-through taxation. The LLC is not taxed as a separate legal entity. The Owners, known as Members, are responsible for paying taxes on the profits they receive. Allocated profits are to be claimed as personal income. This prevents double taxation of the profits. Again, this is if the units of ownership are held by an individual.
Difference #2: Near Anonymous Incorporation
In some states, the members or owner of a LLC are not required to disclose their names and contact information on public record. This provides a high level of privacy for the people behind the company and another layer of protection from creditors.
Ultimately, the purpose of the LLC is to protect the business members from all or some liability for debts and acts of the LLC. The amount of protection provided will depend on the particular state the company is incorporated in. Delaware and Nevada are two states that have structured their laws to protect the owners and members of entities formed in their states. Not all states extend such protections.
There are many states in the U.S. that do not have detailed governance for the operation, dissolution, etc. of a LLC. For further protection partners and company members should have a detailed operating agreement.
The operating agreement can include the responsibilities of each of the positions that will be established within the LLC. The document can also provide extensive protections to the personal assets of all company members. The protections must be within the bounds of state law. Most state governmental bodies will provide a standard operating agreement for partners or members to adopt.
Difference #3: A Buffet of Taxing Options
The LLC is far more flexible than the C-corporation as it can choose to be taxed as a sole proprietor, partnership, S-corporation, or C-corporation. This is accomplish when filling out the IRS form SS-4 to receive the Employer Identification Number.
Difference #4: ‘Small Business Size’ Registering and Licensing Fees
A limited liability company provides a leaner and more flexible incorporation option for small businesses and can be far cheaper to operate. Some states, including Delaware, allow LLCs to be set up with just one person. Delaware also charges a comparably low, flat fee for yearly business taxes.
Some states may charge a franchise tax. The charge is exacted for the privilege of being guaranteed limited liability. Texas charges a franchise tax of as much as $300 per year.
Difference #5: (Downside) Money Problems and Limited Future
The LLC is not a perfect form of incorporation. There are downsides to incorporating under this business type. A major problem with the model is the difficulty to raise financial capital. Venture capitalists prefer the C-corporation model especially for businesses with large IPO potential.
If a LLC desires to raise capital and go public it will be necessary to restructure the business. The remedy is simple in thought but quite tedious in action. It will be necessary to create a new C-corporation and either merge the two or dissolve the LLC, depending on the state it’s filed in.
If you are entering a partnership it is imperative to have a detailed guideline that the LLC will run by. Be sure to set-up an operating agreement that outlines who will have voting rights, how members or managers are selected, and which position will possess the ‘power of the purse’.
C-corporations generally have budgets overseen by chief financial officers. This position is responsible for keeping the company books balanced and tracks spending of company funds. Be sure to allocate a similar role for the LLC.
Difference #6: Two More Flavors of LLC
An individual may also form a Professional Limited Liability Company (PLLC). This incorporation option is used to protect doctors, attorneys, accountants, engineers, and other individuals providing professional services. The particulars of this LLC type will vary from state to state so due diligence is absolutely necessary. Also note that members may still be personally liable for malpractice claims.
Another fascinating flavor of LLC is the Series LLC. With a Series LLC a single incorporated LLC can separate its assets into series. Doing so protects each of the assets individually. For example, if a real estate investment group incorporated as a Series LLC loses a property to foreclosure, the other assets owned by the company will not be affected.
A limited liability company is a great incorporation option for any small or medium size business. It is a great start if you are not ready for the bigger C-corporation model.
Research the requirements for forming an LLC in your state of residence and compare it to doing the same in Delaware. The results may surprise you.