Business Formation - LLC's and Corporations

Forming a Corporation or Limited Liability Company for your business provides some protection from personal liability from the debts of the business.  There are certain structural and tax advantages and disadvantages to the various business entities. The most common business entities for small businesses are LLC's, S Corporations, and C Corporations.
​Because each business and business owner is unique, you should consult with an attorney regarding your business' specific needs to determine which entity is right for you. The information below touches on just some of the characteristics of each entity.
LIMITED LIABILITY COMPANIES - LLC's
LLC's are becoming increasingly popular with small business owners because they provide a lot of flexibility in business structure and taxation. 
  • OWNERS ARE CALLED MEMBERS - An LLC can be owned by one or more persons over 18 years of age, by a corporation or even another LLC.  Each Member has a specific percentage ownership.  There are no shares of stock like a corporation. 
  • FORMATION REQUIREMENTS - An LLC is formed with a state agency. In Illinois, an LLC is formed by filing Articles of Organization with the Illinois Secretary of State and paying a fee.  The Articles of Organization must state  the company's name and contain the words "Limited Liability Company" or the abbreviation LLC. It must also state the names and business addresses of all managers and any member with the authority of manager.  Once registered, the LLC will need to file an Annual Report yearly with the Secretary of State and pay a yearly fee. 
  • MANAGER - All businesses need to be managed.  An LLC's members can choose to participate in the decision-making of the company which is called Member-Managed; or they can select a member, group of members or even a non-member to manage the business which is called Manager-Managed.
  • OPERATING AGREEMENT - All LLC's should have an Operating Agreement. An Operating Agreement is similar to a corporation's By-Laws.  An Operating Agreement sets forth each Member's and Manager's duties and responsibilities in running the business as well as how the finances of the company will be handled. Prior to obtaining financing for your business, most banks will require that you have executed an Operating Agreement.
  • TAXATION - LLC's provide some flexibility when it comes to tax treatment.
    • A Single Member LLC is taxed by default as a sole proprietorship.  An LLC's net profit (or loss) is determined on an individual's 1040 Schedule C, E or F and then the taxes are "passed through" to the individual.
    • A Multiple Member LLC is taxed by default as a partnership.  The net profit (or loss) is determined on a Partnership Return, Form 1065, and is passed on to the Members depending on their percentage share of ownership. 
    • LLC's may also elect to be taxed as a C Corporation or an S Corporation by filing the appropriate paperwork with the IRS and having the proper consents from the members and/or managers as determined by the Operating Agreement.  Because there are a number of IRS rules regarding electing to be treated as a corporation, you should consult with an attorney and tax professional before making such election.
S CORPORATIONS
All Corporations, S corporations and C corporations, are formed by filing Articles of Incorporation with a state’s Secretary of State. After the corporation is formed, certain types of small businesses may elect to be taxed under Subchapter S of Chapter 1 of the IRS code by filing a form with the IRS.  An S corporation’s income, losses, deductions, and credits are divided among and passed through to the shareholders and included on their individual tax returns to be taxed at their personal income tax levels for federal tax purposes.  This allows S corporations to avoid double taxation on the corporate income.  
S-Corporation Requirements
Before electing to become an S corporation, be sure the corporation meets the following IRS requirements:
  • Be a domestic corporation (ie, incorporated within a state of the US)
  • Have only allowable shareholders who
    • may be individuals, certain trusts, and estates and
    • may not be partnerships, corporations or non-resident alien shareholders
  • Have no more than 100 shareholders
  • Have only one class of stock
  • May not be an ineligible corporation (i.e. certain financial institutions, insurance companies, and domestic international sales corporations).
All corporations, including S corporations, are required to hold yearly meetings and keep meeting minutes for the Board of Directors and Shareholders.  Corporations must also file a yearly annual report form and pay a fee to the secretary of state in which the corporation was formed.  If this form and fee is not filed properly, the secretary of state will dissolve the corporation.  
Before electing to be taxed as an S corporation, you should speak to an attorney and tax professional regarding your specific business.  There are a number of rules and deadlines for S corporation election, and mistakes can be costly.
C CORPORATIONS
C corporations differ from S corporation in a number of important respects; most notably, their tax treatment.  C corporations pay tax at the corporate level on its profit.  The corporation then pays its shareholders dividends from the income after taxes.  The shareholders also pay taxes on these dividends at the personal level.  This is what is often referred to as the "double taxation" of C corporations.   
While the double taxation may be seen as a disadvantage, the C corporation also has some advantages such as:
  • A wider range of tax deductions and expenses allowed by the IRS and generally a lower tax rate.
  • No limitation on the number of shareholders which allows for unlimited growth potential making it more attractive to investors and venture capitalists.
  • There are no restrictions on who may be a shareholder such as there are for S corporations.
  • Different classes of stock may be issued for C corporations that are not available for S corporations.