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Corporation vs. LLC?

Every single client of mine who is forming a new company asks me the same question:  Should I form an S-Corporation or a Limited Liability Company (LLC)?  There are more than those two choices (C-corporations, limited partnerships, etc.), but for most small business owners the logical choices are limited to S-Corp and LLC, and the scope of this article will address only those two options.

The short answer to this frequently-asked question is "ask your accountant."  Consider that from the lawyer's point of view, the primary reason to form a company from which you can run your business is protect your personal assets.  That is, if someone is going to file a lawsuit against your business, you want them to sue your company, not you personally.  Thus, in the worst-case scenario, your company loses the lawsuit and the person who has sued can come after anything the company owns, but they cannot touch your personal home or your personal bank accounts/investments (unless you have agreed to personally guarantee your company's debt).  Using a company to run your business thus provides a "shield" that keeps you from having personal liability for debts that your business may incur. 

The LLC has not been around as long as the corporation, so therefore many people do not know as much about it, or do not understand that it functions in exactly the same way for purposes of legal liability.  In other words, regardless of whether or not your company is an LLC or a corporation, you have the exact same "shield" of liability protection if someone sues your corporation or LLC.  There are some administrative differences in how these two types of companies are run, but those are minor and should never be the determining factor in choosing between the two.  Instead, the primary difference is in how they are taxed by the government.  Both the S-Corporation and the LLC are "pass through" entities, meaning that the company does not separately pay taxes in its own name, but instead income is passed through to the company owners, who then pay taxes on the passed through earning.  However, there are subtle but important differences in how the two types of companies can "pass down" that income to the owners (salary? dividend? distribution?), and this is where the difference in taxation lies.           

To make the decision more difficult, my experience teaches me that I could get 10 smart accountants in the same room and ask them whether a particular client should form an S Corp or LLC, with the results being that 4 would say S Corp, 4 would say LLC, and the other 2 would say "it doesn't matter."  Different accountants have different theories on which entity is better for tax purposes, and it will depend on a number of factors, including whether or not the company will own real estate, whether or not it expects to earn profits in the first few years, and whether or not it will have employees.  In the end, this decision should be made with the input of either a business attorney who has significant experience in tax law, or a qualified business accountant.

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