Incorporating a business results in the formation of a new entity that is essentially recognized as a separate person under the law. Incorporation intends to separate the individual founders from the business and partially shields them from certain personal liabilities. In the incorporation process, the company structure evolves from a sole proprietorship or general partnership into a limited liability company (LLC), or a corporation (corp) and the implications of each structure may also further a company’s commercial success. But at the very early stages of your business, how do you know which is the right business entity to form? What is the difference between a C Corp S Corp and LLC?
The three types of entities discussed in this article (C corporation, S corporation, and LLC) all partially shield the individual owners from certain types of personal liability, have varying benefits regarding fundraising and stock option grants, and may provide the company with greater credibility among clients.
Some Legal Implications of Incorporating:
- Partial protection against personal liability: A corporation or limited liability company (LLC) partially shields individuals (stockholders, directors and officers) from business liabilities such as loans, accounts payable, and legal judgments. We use the word “partially” because of how some courts have decided against completely shielding individual owners from personal liability, even when they did not actively participate in the impugned matter. There is a notable recent case, Irizarry v. Catsimatidis, where the owner, CEO, and chairman of a corporation was held to be an “employer” within the meaning of the Fair Labor Standard’s Act (FLSA) and therefore was held personally liable for millions of dollars in damages in a FLSA collective-action liability. Conversely, the assets of the corporation or LLC may be protected if an individual is involved in a personal lawsuit or bankruptcy.
- Transferable ownership: Owners of a corporation or LLC may easily transfer ownership to others, depending on specific state requirements.
- Conversion: Depending on the rules of the applicable state statutes, one type of a business entity may be converted to another (i.e. LLC to corporation) and may even be converted to another state (i.e. from California to Delaware).
- Taxation: Corporations are typically taxed at a lower rate than individuals. Corporations may also own shares in other corporations and resulting corporate dividends can be 80% tax-free (best to consult with an accountant on all tax matters).
- Duration: Either an LLC or a corporation may continue indefinitely and beyond the lifetime of its owners.
- Raising capital: A corporation may raise funds by issuance of convertible debts and sale of stock. An LLC may raise funds by issuing membership interests.
- Credit rating: A corporation acquires its own credit rating unassociated with the owner’s personal credit rating.
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