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I am starting a new business. I am told I need an LLC (limited liability company) or a corporation. What’s the difference?

A limited liability company is a business entity formed by the filing of articles of organization with the Indiana Secretary of State. It is owned by its member or members. The ownership interests of the members in the LLC are often called units. The operation of the LLC is governed by an operating agreement, which sets forth rules concerning management of the LLC, allocation of profits and losses, contingencies in the event of the death of a member, and so on. The operation of the LLC is carried out either by a manager or co-managers, or the LLC can be member-managed, meaning the members make collective decisions concerning the operation of the company. An LLC must file biennial business entity reports with the Secretary of State in order to remain in existence.

A corporation is formed by the filing of articles of incorporation with the Indiana Secretary of State. It is owned by its shareholders, who are issued shares of corporate stock in the corporation. A corporation can have any number of shareholders or a sole shareholder. The corporation is governed by its bylaws, which generally regulate issues like voting, meetings, and duties officers. The corporation is required to have a board of directors which oversees the corporation’s officers. The board of directors appoints the officers of the corporation, such as the president, vice-president, treasurer, and secretary. The corporation’s shareholders and directors are required to conduct an annual meeting. The secretary of the corporation maintains the corporate records including the minute book and stock ledger. Like an LLC, a corporation must file a biennial report with the Secretary of State to remain active. Most small corporations are taxed as Subchapter S corporations, which means that the taxes “pass through” the corporation to its shareholders. If the corporation fails to elect for S taxation, it is called a C corporation. In a C corporation, the corporation is taxed on its income earned and upon distribution to its shareholders, its shareholders are likewise taxed on their income. (This is often referred to as “double taxation.” Failure to elect taxation as an S corporation can be a costly mistake.)

In many respects, LLCs and corporations offer the same benefits. Both offer limitation of liability, meaning that their members or shareholders are shielded from the liabilities incurred by the company, which protects their personal assets from the company’s creditors.

The chief advantage to an LLC over a corporation is its flexibility in terms of taxation and management. An LLC can elect to be taxed as a sole proprietor, a partnership, an S corporation, or C corporation. An LLC also has less rigid rules and formalities for its operation than a corporation.

The most significant advantage to a corporation versus an LLC is the potential avoidance of self-employment tax. In an LLC, the member is treated as being “self-employed” and is taxed accordingly. However, the shareholder of a corporation can often avoid this taxation, as the shareholder is treated as being an employee of the corporation. There is a catch, though: because the shareholder is treated as an employee, the corporation will be responsible for making payroll to the shareholder and withholding taxes. This can create more work and expense for the corporation than the tax savings actually justify.

LLCs are more often used as investment companies where income is rarely or only occasionally realized, such as in a real estate investment operation. Corporations are more often used in businesses that require regular payroll and where there is a more steady flow of income.

Before forming either an LLC or a corporation, the new business owner should consult his or her tax advisor and attorney. These professionals can help the owner make the right choice for his or her new business.