Limit Your Risk – Incorporate!
One of the most common questions that my clients ask is whether or not they should start up a limited liability company (“LLC”) or corporation to operate their business. For most of my clients, if they can afford it the answer is yes they should. Below I will provide information about the benefits of operating as a LLC or corporation.
Many sales agents and even some ISOs operate as a sole proprietorship or as a partnership. There is nothing particularly wrong with operating on this basis other than the fact that your personal assets are all at risk for the obligations of the company. As a sole proprietor, any time you enter into a contract or other business transaction, your personal assets including your house, car and bank accounts could potentially be seized to satisfy the obligations of your business.
If you operate your business as an LLC or corporation, you can shield your personal assets from being used to satisfy the debts and obligations of your business. An LLC or corporation is a legal entity that can enter into contracts and other business obligations separate and apart from you as the owner of the company. If you do enter into a business transaction on behalf of the company, you as the business owner are shielded and your personal assets are protected from being used to pay for the losses and other obligations of the company. However, because of this, some banks and landlords will require you to enter into a personal guarantee for bank loans and leases. But, barring that, setting up an LLC or corporation can under most circumstances protect your personal assets.
One question I often get is which one to choose – corporation or LLC? From a liability standpoint, it does not matter. Many people mistakenly believe that an LLC somehow does not provide the same shield from liability for the owners’ personal assets as a corporation. That is totally false. From an asset protection standpoint, LLCs and corporations are exactly the same and both provide the same shield for your personal assets.
Most people choose the LLC because it is the easiest to organize and maintain. In order to organize an LLC, you need to first file your articles of organization in the state you intend to operate. If you are a single owner LLC, arguably that is all you have to do. In most states, you do not even have to enter into a written operating agreement, the main document that memorializes how the LLC will operate. Even if you do enter into a written operating agreement, which is advisable if there is more than one owner, you do not have to do anything else to maintain the LLC, such as annual minutes that you would have to do if you establish a corporation. Given the ease of organization and the fact there is no need to do annual minutes to maintain an LLC, from an organizational perspective an LLC is superior to a corporation.
Both an LLC and if you elect to be an “S” corporation are what are called “pass through” entities for tax purposes. What that means is that the LLC or corporation is disregarded for tax purposes and the income and expenses of the company flow through directly to the owners. The benefit of this is that there is no tax at the corporate level on the income or revenue of the corporation or LLC. If you are a “C” corporation, the income of the corporation is taxed at the corporate level, resulting in double taxation. For that reason, for most small businesses it is never a good idea to operate as a “C” corporation.
However, for tax reasons you may be better off with a corporation than an LLC depending on that state you are operating in. In some states, there are taxes charged to LLCs that are not charged to corporations. For instance in California there is a tax of one half of one percent on the revenue earned by an LLC. In contrast, for an “S” corporation there is a tax of approximately one percent on the net profits of the corporation. This results in a situation where as revenue grows, if your net profits are not that great due to business expenses, it ends out being less costly to operate an “S” corporation as compared to an LLC in California. You should consult a tax professional in your state in order to determine the right tax choice for you.
Where to Incorporate:
Many people believe that certain states are better to organize your corporation or LLC than others. For the most part that is not true. Delaware is one favorite place to incorporate for many companies but the benefits of incorporating in Delaware do not apply if you are a small company where the officers, directors and owners are all the same group of people. No matter what, you have to be registered in the state where you are operating, even if you are incorporated in another state. So if you are operating in West Virginia and you want to organize your company in Delaware, you end out having to pay taxes in Delaware and paying to register your company in West Virginia. This usually ends out being more expensive than if you just started up a West Virginia company. For that reason, you are generally better off just organizing your company in the state that you are operating in.
There are many benefits to incorporating. As long as you can afford it, my advice to my clients is almost always that starting up an LLC or corporation to operate your business is a great idea.
The information contained herein is for informational purposes only and should not be relied upon in reaching a conclusion in a particular area. The legal principles discussed herein were accurate at the time this article was authored but are subject to change. Please consult an attorney before making a decision using only the information provided in this article.