On the other, they desired the personal liability protection offered by incorporation. Traditionally, it was possible to achieve these dual goals only by forming a corporation and then applying for S corporation status from the IRS. Then a few years ago a new legal entity, the limited liability company (LLC) was introduced. LLC’s, which are recognized by all states can have many of the most popular attributes of partnerships (pass through tax status) and corporations (limited personal liability for the owners). Most states allow a one person LLC but some states require an LLC to have at least two owners, meaning they are not suitable for sole proprietors except where a spouse is included as a co-owner.

LLC’s, like corporations, are formed by filing Articles of Organization with your state’s corporate filing office, usually the Secretary. Then the parties prepare and adopt an Operating Agreement which is similar to a Partnership Agreement which sets forth the rights and responsibilities of the parties involved.

Here are the main features of the LLC, which make it attractive to many small business owners :

Limited liability. Until the LLC came along, business owners were personally on the hook for all the business debts, including liability from most lawsuits, unless they incorporated. But LLC owners are not personally liable for business debts, such as court judgments or legal settlements obtained against the business. They risk losing only the amount they paid into the business to get it started. (If however, you personally co-sign a loan, you are personally liable, no matter how the business is set up.)

Flexible management. The owners of an LLC are called members. Small LLCs are normally member-managed, since most small business owners want and need to have an active hand in running the business. Members can, however, elect a management group, which may include nonmembers.

One-level of taxation. The LLC, like a partnership, is normally recognized by the IRS as a “pass-through” tax entity (you can also elect to have it taxed like a corporation which for some business owners can result in lower overall taxation); LLC’s can even elect S corporation tax status, but this is a complicated tax strategy that puts LLC’s in a quasi-partnership type of tax treatment). Unless you choose corporate tax treatment, the profits or losses of the LLC are not reported and taxed at a separate business level, as are corporate profits. Instead, they pass through the business and are reflected and taxed on the individual tax returns of the owners. (Sole proprietorships and corporations that have elected S corporation status with the IRS are also pass-through entities with similar tax status.)

Flexible distribution of profits and losses. When a business is co-owned, the owners may or may not wish to split profits and losses of the business proportionately to capital contributions. Different business forms have different rules about how business profits, losses and assets can or cannot be split up. The corporate form is generally the most rigid, and partnerships the most flexible; S corporation tax status falls somewhere in between. The LLC is treated like a partnership for tax purposes, and this applies to the division of profits and losses of the LLC.

However, LLC’s may not be for everyone. Although LLC’s may be the best choice for some business owners who wish to limit their personal liability for business debts and claims, some would be better off forming a corporation. For example, a business that would benefit from a formal separation of management from financial interests–as is found in the separation of the corporate board of directors from its shareholders, with each group subject to separate legal rules, responsibilities and decision making power–or a business that looks forward to issuing stock incentives to employees or selling its shares to the public should consider incorporating instead of forming an LLC.

Practical Suggestions

Many accountants I work with are still recommending the S corporation for operating a small business which offers a service or sells a product. For people who need an entity for buying, selling or holding real estate or for holding other assets, the LLC may be the best choice. Both entities provide similar limited liability protection. The only difference is that S corporations have been around for so many years that there are a lot of legal decisions determining various issues of liability which make them more predictable. LLC’s are relatively new and their treatment by the courts is less predictable. With respect to taxes, many accountants suggest you can save some money in the area of FICA taxes (the 15.3% Social Security and Medicare Taxes) in an S corporation where the same treatment is generally not available in an LLC.

Some accountants suggest using an LLC that elects S corporation tax status. This is certainly a possible way to get the best of both worlds but is a fairly new strategy and not familiar to some accountants or tax practitioners

The most basic pre-paid plan is designed to make the simple legal services readily available to the general public at low cost. These plans typically cost between $10 and $30 per month, billed in advance.

You get unrestricted toll-free number telephone access to a lawyer for legal advice and consultation. You can also make brief office consultations to talk to your lawyer about any legal problems you may be encountering. Your lawyer can also write to letters or make phone calls on your behalf. This can help resolve many problems before they escalate further.

Other services provided are not overly time-consuming: the drafting of your will to distribute your property after your death, review of your trust and any other simple legal document.

If you require any other service beyond the scope of a basic plan, then you can either pay discounts on regular lawyer fees or pay a premium to upgrade to a more comprehensive plan.

Request a free consultation on the process of setting up a company in the USA.

In a prepaid legal service plan, the customer pays a fixed monthly
subscription fee of up to $25 for the services of pre-selected lawyers.
The most basic plans provide advice and consultation by telephone. Plan
members receive a few hours of free office consultation with their assigned
attorney. They may also include review and advice on simple legal documents,
preparation, drafting or an update of a simple will. Phone calls and letters
can be written on behalf of members, a service helpful for credit problems
and consumer protection.

More comprehensive plans cover clients’ personal legal needs ranging from
services that require more time and effort on the part of your attorney,
such as contracts, wills and deeds, to legal representation in negotiations
and courts cases related to family matters, bankruptcy and real estate
issues.

For these reasons, it is generally not beneficial or realistic
for smaller companies to attempt to go public. In the past few years,
the reporting requirements for public companies have grown and
require more legal and accounting expertise and expense. One
example is that public companies are now required to have
independent board members (meaning they cannot be shareholders
or have significant benefits in the company) and an independent
auditing committee that oversees the company’s financial matters.

Due to the potential liability of being on the board of directors or on
the audit committee, few people are willing to serve unless they are
paid a substantial sum of money and are provided with liability
insurance from the company. Liability insurance for directors of a
public company is expensive. Because of the many requirements
placed upon public companies, some companies, which were once
public companies, have opted to become private companies.

When a business has grown substantially and has sufficient
revenues, it might consider going public. The benefits include the
ability to sell stock to the public to raise money and it provides an
exit strategy to the original shareholders or owners by giving them a
way to cash out of the company. It also provides shareholders with
a more liquid investment because there is a public market where they
can sell their shares.

A public corporation is one that is authorized to sell its stock to the
public. Usually, only companies with substantial revenue and a large
number of shareholders can afford the cost to go public and comply
with the many regulations imposed on public companies by the
securities laws and other governmental regulations.

Usually, the statutes provide that
only a person holding the license required to practice the
professional service can be a shareholder or at least a majority
shareholder. In addition, only those holding the professional license
can normally be a director or officer of the corporation except for
the corporate secretary. The reason for these restrictions is that the
professionals are strictly regulated by license requirements of their
profession and the law does not want unlicensed people making
decisions that might compromise the professional’s judgment on
matters within their expertise.

My experience is that in some cases this may make operation of a
small corporation easier but on the other hand, it sometimes
complicates it because the business world is accustomed to dealing
with directors. For this reason, owners or shareholders of a “close
corporation” may find themselves trying to explain to a banker or
other business person why they don’t have directors and why they
don’t need director approval for various corporate actions. As a
practical matter, the “close corporation“ structure may not provide
that much benefit after all.

The cost of incorporation in your home state will usually be less than
incorporating in a different state and then trying to qualify to do
business as a foreign (meaning from another state) corporation. A
foreign corporation that qualifies to do business in another state is
subject to taxes and annual report fees from both the state of
incorporation and the qualifying state. Another disadvantage of
incorporating outside of your home state is the possibility of having
to defend a lawsuit in another state. You will also have to maintain a
registered office and agent in the other state, which is an additional
cost each year.

If you operate a business, within no particular location or home base,
such as an internet business, then you might want to consider
Nevada or Delaware. However, you may find the cost of operating
and maintaining your corporation higher in Delaware than in your
home state due to the franchise fees charged by Delaware and the
need for a registered agent in Delaware. Many large corporations
are domiciled in Delaware but my opinion is that Delaware does not
provide many benefits to smaller companies that could not be found
in their home state.

Nevada promotes the incorporation business by claiming no state
income taxes and not sharing tax information with the IRS.
However, if you do business in another state, you will likely still pay
state taxes in the state in which you conduct business. Each state has
its own formula for deciding if a business owes state taxes. It’s best
to consult an accountant about this question. As far as sharing tax
information with the IRS, the IRS can obtain your records in Nevada
by way of subpoena if they want. Also, I believe in being aggressive
with tax savings, but not cheating. So what do you have to hide?

Nevada promotes the incorporation business and a lot of
incorporation services have sprung up there. Some of these offer
valuable services while others advocate advantages, which are more
puff than reality. Due to this and the large number of corporations
formed in Nevada, some experts say that Nevada incorporating has
developed a questionable reputation with the IRS and may subject a
business to a greater likelihood of an audit if it is formed in Nevada.

If you are looking to incorporate offshore for liability protection,
there are several important considerations. First, in order to protect
assets, you will need to transfer the assets into the offshore
corporation, which will likely involve moving them to the offshore
country or location. There are a lot of horror stories about people
losing their assets in offshore companies. You need to be very
careful about whom you trust and whom you do business with.
Secondly, you will be dealing with laws from another (offshore)
jurisdiction that may be considerably different than the local
corporation laws or US laws that you are used to.

In most cases, the risk and effort in setting up an offshore
corporation will outweigh any potential benefits you might receive.

The main disadvantage of incorporating is the cost and extra time
involved in getting organized and operating the business as a
corporation. Once the corporation is set up, it may not involve much
more time than just operating a sole proprietorship. Any business
requires that you keep records for tax purposes.