Corporations and Limited Liability Corporations (LLCs)

Please keep in mind this article is not intended as, or a substitute for, legal advice.

Incorporating or forming an LLC (Limited Liability Company) for your business is an event that has grown much bigger in many people's minds than it really is or needs to be.

The decision is fairly straight forward, and with a little logic and common sense you should be easily able to determine what is right for you.

There are also many myths and lots of misinformation around the topic, which we will try to dispel here.

The are several key things to look at when deciding whether to pursue one of these options. They are:

• The expected size of the business
• The assets of the business founder(s)
• The number of people owning the business

The size of the business is not critical, except that in general, for a very small business the cost of incorporating, although low, is still not worth the expense. If you are going to be operating part time, or from home, and don't expect sales of more than ten to twenty thousand a year, the cost of incorporating is going to eat up too much of the profit of the business, and it isn't likely to be of enough benefit to justify the cost.

Since such a small business is unlikely to attract a lawsuit, unless it is in a particularly litigious market, and it isn't likely to be taking on any significant debt, then incorporating likely isn't necessary. If the business grows beyond this size, then the subject can be revisited.

The above may not hold, however, if the owner of the business personally has a large amount of assets they may want to protect. If you are wealthy, or you have a partner who is, then incorporating may be worth the cost just for the peace of mind it will give you in protecting your personal assets, such as a home, retirement savings, other businesses, etc. Incorporating will keep your other assets safe from problems this business may run into, providing you don't break the rules.

The number of people owning the business is another consideration. Any time more than one person owns a business, there is potential for fallout, partnership splits, or other problems that will affect the business negatively. In these cases, having the business be a corporation will keep the rest of the partners' assets shielded from problems encountered by the business. In general, with two or more people having ownership, a corporation is a very good insurance policy against things going too wrong with the business.

Of course, the rules still have to be followed, but assuming they are then the business will be far easier to keep viable and protected if there are any partnership problems. So, if you have a business that will grow past twenty thousand in sales, or you have personal assets of some value, or you have a partner or two, you will probably want to seriously consider incorporating. Now is where we come to some of the myths and misinformation we want to dispel before you go further:

Myth- It is better to incorporate in Delaware, Nevada, or Offshore

Fact- Although there are many, many services touting incorporation in these states, or even on offshore "havens" the truth is there is no advantage and lots of downside.

First, it is more expensive to incorporate out of state, because not only will you have to also incorporate in whatever state you actually do business in, but you will also have to pay extra fees and pay to keep a registered agent in the incorporated state (a physical address where legal notices can be sent). Although it is true these states have somewhat more lax corporate governance rules, if you want to take advantage of them in an actual case you have to hold the trial there- adding another huge expense.

And it is untrue that there is really easy credit available to your corporation, if your corporation has no assets and you personally don't have good credit. Basically, it is just a way for these incorporation companies to make extra fees from you. Unless you are going to actually have business operations or live in Delaware or Nevada, there is no real advantage and plenty of disadvantages to incorporating out of state.

Myth- Having a corporation is a lot of extra work. Complying with the reporting regulations is a nightmare.

Fact- Actually, for the typical small business, being incorporated is no big deal at all. You do have a couple forms to file you wouldn't have otherwise, but they only take a few minutes. You are also required to hold an annual meeting (for corps, not LLCs) but again, that need only take a few minutes.

Your accountant or tax person can file the required tax paperwork, or you can do it yourself with Turbotax or Quickbooks or a similar program. In reality, the "extra work" is hardly anything, and not a reason to decide not to file.

Myth- Incorporating a business creates big additional expenses.

Fact- It does create some additional expenses, but they aren't that big. Depending on your state, there is an annual fee, and you may also pay tax on your profits, depending on how you set up your corporation. Overall, though, having a corporation may actually save you quite a bit more money than it costs you.

For example, by having a S-Corp and paying yourself a smaller salary and taking the rest in profit, you can save yourself lots of money in self employment taxes you would have otherwise paid if you weren't an S-Corp. This savings would more than offset the annual fees, and put more money in your pocket.

Myth- Incorporating will mean paying double taxes.

Fact- In theory you may owe taxes on both the corporate level and the personal level. The truth is, however, that there are many ways around this, and there is never a reason to have to suffer this problem as a small business. Your accountant or tax advisor can help you arrange your business so this won't happen to you.

So, now that you know you won't have a lot of hassles, or expenses, or taxes, and that incorporating can actually put more money in your pocket than not filing, the question that remains is what to file as- a corporation or an LLC.

They are very similar, really. More people recommend LLCs to startups than corporations, because they have a little more flexibility in a couple ways. One is that if there are multiple owners, the profits and losses can be split in a different ratio than the actual ownership.

That may be helpful in some cases, although it isn't likely to effect the majority of startups. The other advantage is there are fewer limits on the number of owners or the types of owners that can be involved in the business. Again, though, that isn't likely to apply to very many people.

The advantages of a corporation are that the legal form has a longer legal history, which means that the courts are more predictable in how they deal with corporate cases, and an Inc. at the end of a company name probably has a little more cache than an LLC does at this point in history, just because it has been around for so much longer.