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Corporation vs. Limited Liability Company

What is an LLC?

An LLC is a business structure designed to provide the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership. As a pass-through entity, all profits and losses pass through the business to the LLC owners (aka 'members'). Similar to partnerships, the members themselves report the profits/losses on their federal tax returns but not the LLC. Nevertheless, some states do charge the LLC an income tax.

Advantages and Disadvantags of an LLC

The most attractive feature of an LLC is its operational ease. LLCs have lower start-up costs and fewer required forms. Taxes only need filing once a year on April 15th. A single-member LLC files a 1040. Schedule C as a sole proprietor; partners in an LLC file the same 1065 partnership tax return as do owners of traditional partnerships. . Finally, LLCs are not required to have formal meetings and record meeting minutes.

However, there are some limitations and drawbacks. Generally, you'll pay more in taxes with an LLC, This is because the owner of an LLC is considered to be self-employed. As such, he or she must pay a self-employment tax of 15.3% which goes toward social security and Medicare. The entire net income of the business is subject to self-employment tax.

Keep in mind that the IRS also limits the 'characteristics' of your company. An LLC may only have two of the four characteristics that define corporations: 'Limited liability to the extent of assets, continuity of life, centralization of management, and free transferability of ownership interests.' Therefore, if you wish to have more than two of these characteristics, you'll need to convert to a corporate business structure.

What is an S-Corporation?

An S-Corporation is a business structure that is considered by law to be a unique entity, separate and apart from those who own it. So there's a limit on the financial liability of an owner (shareholder).

What differentiates the S-Corp from a traditional corporation (C-Corp) is the ability to have profits and losses pass through to the shareholder's personal tax return. Consequently, the business is not taxed itself, only the shareholders. There is an important caveat: any shareholder who works for the company must pay him or herself 'reasonable compensation.' Basically, the shareholder must be paid fair market value, or the IRS might reclassify any additional corporate earnings as 'wages.'

Advantages and Disadvantags of an S-Corporation

One of the best features of the S-Corporation is the tax savings for you and your business. Members of an LLC are subject to employment tax on the entire net income of the business. Conversely, only the wages of the S-Corp shareholder who is an employee are subject to employment tax. The remaining income is paid to the owner as a 'distribution' which is taxed at a lower rate if at all.

Unlike LLCs, both S corporations and C corporations can go public. For that reason, venture capital companies prefer to work with corporations rather than with LLCs. S corporations, like LLCs, don't suffer from double taxation. C corporations may face double taxation, but they can have incentive stock option plans.

Piercing the Corporate Veil

If a court pierces a company's corporate veil, the owners, shareholders, or members of a corporation or LLC can be held personally liable for corporate debts. This means creditors can go after the owners' home, bank account, investments, and other assets to satisfy the corporate debt. But courts will impose personal liability only on those individuals who are responsible for the corporation or LLC's wrongful or fraudulent actions; they won't hold innocent parties personally liable for company debts.


This May Occur When

  1. There is no real separation between the company and its owners. If the owners fail to maintain a formal legal separation between their business and their personal financial affairs, a court could find that the corporation or LLC is really just a sham (the owners' alter ego) and that the owners are personally operating the business as if the corporation or LLC didn't exist. For instance, if the owner pays personal bills from the business checking account or ignores the legal formalities that a corporation or LLC must follow (for example, by making important corporate or LLC decisions without recording them in minutes of a meeting), a court could decide that the owner isn't entitled to the limited liability that the corporate business structure would ordinarily provide.

  2. The company's actions were wrongful or fraudulent. If the owner(s) recklessly borrowed and lost money, made business deals knowing the business couldn't pay the invoices, or otherwise acted recklessly or dishonestly, a court could find financial fraud was perpetrated and that the limited liability protection shouldn't apply.

  3. The company's creditors suffered an unjust cost. If someone who did business with the company is left with unpaid bills or an unpaid court judgment and the above factors are present, a court will try to correct this unfairness by piercing the veil.