Business Law 101 / Why choose a Corporation or LLC
By Albert L. Kelley
So you’ve decided to start a new business and you know you want either a corporation or a limited liability company. But what sets them apart? We’ve already seen that the structure of the two is extremely similar. What makes one really different than the other?
The reason to form either a corporation or limited liability company is to reduce personal liability based on actions of the company. As a general rule, neither shareholders or members have personal liability for issues involving the corporation or LLC. While directors and managers can still have personal liability, so long as they act in a manner consistent with the bylaws are operating agreement and are complying with the law, the liability is also limited. The first major issue to consider are taxes. There are two types of corporations: C corporations and S corporations. The easiest way to think of these are in terms of size; C corporations tend to be large and include most of you probably traded companies while S corporations are small with most being mom-and-pop type operations. With a C Corporation, the corporation must file an annual tax return (due by March 15) and pay income tax based on the profits of the corporation. If the shareholders then receive a dividend based on the profits, they must pay income tax on the dividend. In other words, the shareholders of pain tax twice on the same money. Let’s use an example: the Corporation makes $100,000 in profit. If they have a 25% tax bracket, they will pay $25,000 in taxes living a profit of $75,000. That $75,000 is then paid to the shareholders. If they are in a 20% tax bracket they will pay an additional $15,000 to the Internal Revenue Service, leaving a net profit of only $60,000 of the original $100,000. That level of taxation is generally too high for small corporations. So to alleviate the impact, Congress created the S corporations (also known as the subchapter S corporation).
Subchapter S corporation has the exact same structure as a C corporation however it must comply with four basic rules: it can have no more than 75 shareholders, all shareholders must be natural persons, the corporation cannot make the majority of its income by investing in other companies, and the fiscal year must end on December 31. These rules designed to ensure that as corporations remain small business. The difference between the S corporation and a C Corporation is that an S- corporation pays no income tax. The IRS deems it a nonexistent entity so that all of its profits flow through the corporation directly to the shareholders. In other words using our example above, if the Corporation makes $100,000 in profit, the corporation will file a tax return and issue a k-1 form to the shareholders showing they made $100,000. The shareholder then files their tax return and that there are the 20% tax bracket, they pay $20,000 in taxes, making a net profit of $80,000. It is a substantial savings.
However, there is a downside of corporations. Shareholders own stock in the company which is deemed a personal asset. If the shareholder gets sued personally, the judgment creditor can seize their stock to satisfy the judgment. This is one of the reasons for the creation of the Limited Liability Company. But we will discuss that in the next column.
Al Kelley is a Florida business law attorney located in Key West and previously taught business law, personnel law and labor law at St. Leo University. He is also the author of “Basics of Business Law” “Basics of Florida’s Small Claims Court” and “Basics of Florida’s Landlord-Tenant Law” (Absolutely Amazing e-Books). This article is being offered as a public service and is not intended to provide specific legal advice. If you have any questions about legal issues, you should confer with a licensed Florida attorney.