Should My Business Be a Corporation or a Limited Liability Company?
At DiMonte & Lizak, our clients who are starting a business often ask us to advise them as to whether they should operate their business as a traditional corporation or as the newer type of entity, the limited liability company. Our recently deceased partner, Linscott R. Hanson was one of the authors of the Illinois Limited Liability Act, and our firm has always been comfortable recommending either the LLC or corporate entity for our clients.
When we advise our clients, we focus on the differences between corporations and LLCs regarding the following factors: Financial Cost, Management Flexibility, Income Tax Results and Liability Protection.
The Illinois Secretary of State is charged with administering registration of both corporations and LLCs. Their filing fees occur upon initial filing and annually upon renewal of both types of entity. The fees are lower for corporations: $175.00 for initial incorporation for a corporation vs. $500.00 for organization of an LLC, and $100.00 annual corporate renewal vs. $250.00 for annual LLC renewal.
Also, attorney=s fees at organization are lower for corporations: with multiple partners, corporations typically require fairly standardized buy-sell agreements while LLCs require a more complicated and nuanced operating agreement. However, Illinois laws require more annual corporate documentation for corporations than for LLCs, so attorneys fees for proper annual reporting and meeting documentation are somewhat higher for corporations.
A major drawback for corporate ownership is inflexibility, especially in two person entities. With two equal business partners, our clients typically wish to share decision making. With a corporation, only one shareholder can be President, and the President determines business operation decisions. With equal owners, disagreements can lead to deadlock, and the non-president shareholder is unable to have a voice in management. With an LLC, both members can share management rights and duties and we typically draft dispute resolution procedures into the operating agreement or at least require unanimous consent for major decisions. This is why legal costs are higher to draft LLC initial documents: these documents can be more flexible and thus are more extensive and complicated to draft.
Income Tax Results
LLCs have a disadvantage as to social security and medicare tax costs. While the LLC itself is not taxed on its income, its members report their share of the LLC=s income personally, and all income is employment income for social security and medicare tax purposes.
S-Corporations are more flexible – as long as the shareholders pay themselves a reasonable salary, the excess corporate profit above their salaries is taxable to the shareholders as a dividend and not as social security or medicare wages, thereby avoiding employment taxes on that excess income.
In addition, in the right circumstances, a corporation can choose not to be a “S-Corp” and pay its own taxes, but the owners= deductible deferred (pension) compensation can reduce that corporate profit and benefit the owners through tax deferral.
Our clients operate their businesses as LLCs or corporations primarily to protect their personal assets from the liability that can result from operating a business. Both corporations and LLCs accomplish that all-important goal. Though very difficult if an LLC or corporation is properly maintained and operated, in some instances it may be possible for creditors of a business operated as an LLC or corporation to attempt to “pierce the veil” to attach the personal assets of a shareholder or member to satisfy the business= debt. Recent Illinois case law has made it clear that LLCs are superior to corporations in protecting owners of the business from such liability.
Every client and type of business involves unique considerations, but our firm explains and applies the above factors in advising our clients in choosing their entity.