While both types are separate legal entities from their owners (shareholders), only C-Corporations operate as a separately taxed entity from their owners.

This means that the shareholders, employees, owners of a C-corporation pay tax on their personal salary, while the corporate profits are taxed separately (and often at a lower rate). The downside to this is that when the after-tax profit is dispersed as dividends, it is taxed again (although tax laws do change from time to time).

S-corporations are not treated as separate taxable entities like C-Corporations. Because of this, net income is passed through the S-Corporation to the personal income tax of the owner(s).

What does this mean? It means a completely different taxing structure. C-Corporations must file and pay taxes with the IRS, separately from he income/salary/bonuses of the owners and employees. The first $50,000 of taxable corporate income is federally taxed at a rate of 15%, and the next $25,000 is taxed at 25%.

S-Corporations do not face the same taxing burden. Because the profits pass through to the shareholders, the business does not have to file taxes in the traditional way. They simply need to file a form 1120S, which is similar to the filing required for a C-corporation, but it is only an informative document; no corporate income taxes are paid to the IRS for the S-corporation. The owners pay personal income taxes as follows: Compensation (in the form of salaries, bonuses, etc.) is treated as ordinary personal income for federal taxation purposes and are subject to payroll taxes, whereas after compensation corporate net income is distributed to the shareholders in proportion to their share of company ownership and is treated as a non-qualified dividend (i.e. Such income is taxed at the personal income tax rate, but is not subject to payroll or self-employment taxes).

Both corporations are controlled by shareholders – each “share” is actually a tiny stake in the company (i.e.: a common share of stock.) These shareholders have a limited personal liability, meaning they cannot lose more than they invest. It also means that their company will always exist, unless they choose to close it (and assuming that any reporting and tax requirements are met and kept current, and the corporation otherwise stays compliant with the law).

While there are generally no citizenship or residency requirements to be a shareholder of a C-Corporation, this is not the case for an S-Corporation. United States citizens and resident aliens are generally free to own shares, non-resident aliens are barred from ownership in an S-Corporation.

While an S-Corporation can be perceived to have a better personal financial impact, they are subject to restraints that do not bind C-Corporations.

S-Corporations may not:

* Exceed 100 shareholders.
* Have shareholders who are non-resident aliens.
* Have more than one class of stock.

Have shareholders that are other corporate entities; S-Corporation shareholders must be natural persons.

C-Corporations are not subject to these restraints, giving them more room to grow and expand.

Both S and C-Corporations offer positives and negatives. While S-Corporations may have better circumstances with which to profit the principals (in most cases), C-Corporations have more flexibility, allowing them to expand beyond the scope of most S-Corporations.

While quite similar in many respects, LLC’s and S-Corporations both have advantages over one another.

For example, while LLCs and S-Corporations share the same “separate entity” status enjoyed by corporations (meaning the company is a separate entity from its owners), the profits and voting power are not necessarily allotted the same way.

An S-Corporation divides profits between its shareholders evenly. Someone with 30% of the stock would receive 30% of the profits while another with 10% of the stock would receive 10% of the profits, and so on.

This is not the case with the LLC. In an LLC, the members (akin to stockholders, although LLC’s usually issue “member units” as opposed to common stock) decide how profits should be divided. There may be someone with 10% of the “stock”, but they put in 30% of the work. This stockholder can receive more than what they have invested if the other members agree that they deserve it.

The same goes with voting power. S-Corporations follow a more traditional structure by which voting power is determined by stock ownership. An LLC can give more or less voting power to stockholders regardless of how much stock they may own.

Also, there are several other abilities an LLC has that do not apply to S-Corporations.

LLCs:

* No ownership restrictions – virtually anyone (individuals, Corporations, other LLC’s, and even foreign entities may be owners of an LLC).
* Can operate with a single member.
* Are not required to hold annual meetings.

An S-Corporation has separate ownership provisions. The S-Corporation is limited to 75 shareholders all of which are required to be US citizens. They are also required to hold shareholder and corporate meetings, which can affect record-keeping needs and continuity within a company.

LLCs sound pretty good, right?

Well (and you knew this was coming), there are some down-sides too.

For starters, S-Corporations get better deductions in regards to benefits (health insurance, etc.)

The status of the pass through income is a little different as well for the personal service principals (the principals that are employees.) It is considered “passive income” and not “earned income (like it is with an LLC.) Thus, Social Security and Medicare taxes (at this writing) are not levied.

In addition, LLC’s may have a limited shelf-life. Some states have a cap on how long they can stay in business (30 years, etc.)

In closing, you could say that S-Corporations allow for more shareholder uniformity and tax savings, while an LLC allows more free negotiations and possibilities for ownership and accountability. You can almost think of an LLC as a marriage between a classic small business (partnership / sole proprietorship) and a corporation.

One advantage of the S Corporation is that like the LLC it receives pass through taxation. Pass through taxation simply means that federal income tax is not assessed at the entity level; profits are distributed in the form of dividends and flow through to the individual tax returns of the shareholders, and the IRS taxes the shareholders at their individual income tax rate and not at the entity or corporation level. Therefore the S Corporation, unlike the C Corporation, is not subject to double taxation. Since net losses are “passed through” as well, the individual shareholder may be able to reduce his or her tax liability by offsetting other income with any S Corporation losses. One of the most enticing advantages of the S Corporation is its ability to minimize payroll / self employment taxes which can be a significant amount of money, currently the rate is set at 15.3%. For example let’s take an S Corporation with a single shareholder, if the company was to have a net profit of $90,000.00 and the shareholder / employee assigned himself a salary of $25,000.00 he would be able to reduce payroll / self employment taxes by $9,945.00. This is because only the $25,000.00 salary portion would be classified as earned income and subject to payroll / self employment taxes, the remaining $65,000.00 would pass through as a non-qualified dividend. While taxed at the personal income tax rate of the shareholder, the $65,000.00 is exempt from the self-employment / payroll taxes.

Companies doing business as an LLC have the same advantage of pass through taxation; however a single member LLC is treated as a disregarded entity by the IRS. The business entity is disregarded as a separate entity from its owner for Federal tax purposes; essentially what this means is that the IRS classifies the single member LLC as a sole proprietorship and since all income from a sole proprietorship is treated as earned income the full $90,000.00 would be subject to the 15.3% payroll / self employment tax. For this reason, an S Corporation could be viewed as a superior entity choice for the individual owner who is looking to minimize his or her payroll and self-employment tax exposure.

A multimember LLC is treated by the IRS as a Partnership as the default status for federal tax purposes. This requires that the LLC file the Form 1065 Partnership return (informational only – the LLC does not pay federal taxes), and the net income (or loss) passes through and is accounted for on the tax returns of each individual member.

Companies doing business as S Corporation must first form a standard corporation with the state (and the default federal tax status at that point is that of a C Corporation). After the corporation is formed with the state the company must file an IRS Small Business Tax Election form 2553 stating their intention to be taxed as an S Corporation. IncFile prepares the Form 2553 and returns it to you for your signature along with your filed corporation, and after the initial shareholders have signed it can simply be faxed or mailed in to the IRS. The IRS Form 2553 must be signed and submitted to the IRS within 75 days of the date of formation of the Corporation.

Small business owners are especially at risk of stumbling into this particular pitfall. Since they are often overwhelmed with the multiple facets of their business’ day-to-day operating needs, they may not know how to avoid noncompliance and the resulting crippling or fatal business consequences. IncFile.com can help.

Corporations and LLCs have both internal and external ongoing requirements. The internal requirements must be met by the directors of the corporation or the members of the LLC, and then documented in company records. External requirements are those imposed by the state in which the LLC or corporation was formed; these often include, at a minimum, an annual (every year) or biennial (every two years) filing with the state, as well as some kind of fee.

Internal Requirements

Internal requirements are frequently overlooked, but are vitally necessary to effective decision-making and communication within the organization. A corporation has more internal requirements than an LLC; these include holding and properly documenting director and shareholder meetings, adopting and updating bylaws, issuing stock to shareholders, and recording stock transfers. While these actions are not specifically required for an LLC, it’s still a good idea to adopt an operating agreement (and keep it up to date with amendments as needed), issue membership shares, record interest transfers, and hold annual meetings.

Owners use a consolidated corporate records book to organize and maintain important corporate documents such as articles, bylaws, meeting minutes, resolutions, stock certificates, deeds, and so on. Many business owners use a Corporate Kit or LLC Kit for organizing and maintaining these vital records. Many businesses also use a metal or rubber corporate seal—the kind that leaves the company name in raised letters on a document—to signify that the document is an authorized, official transaction of the corporation. These can be obtained as part of a corporate kit or from a stationery store.

Bylaws lay out the corporation’s basic operating principles; they should be planned for and drawn up as part of the incorporation process. It is not required to file the bylaws with any government agency, but a corporation is required to have at least an initial and annual meetings, adopt bylaws, and keep minutes of the meetings, and keep these on file with the corporate records. Bylaws are important because they set down formal rules for such things as: when and how meetings can be held; notice, quorum, and voting rules for meetings; how decisions can be reached and recorded outside of meetings; basic titles and responsibilities of corporate officers; and the requirements for providing periodic (usually at least annual) information to shareholders.

In short, bylaws are the corporation’s major decision-making and operating procedures set down on paper. This can help owners refine and improve their common practices, and can also serve as a “referee” when uncertainty or disagreements arise on what the official solution is to a given situation or need. Bylaws also give your firm credibility in the eyes of shareholders, creditors, potential investors, other businesses, and even the IRS. Owners should take care, though, to make sure their bylaws do not conflict with their state’s Business Corporation Act or its equivalent.

If the board of directors is not already appointed in the articles of incorporation—a requirement in some states—the initial board’s names and addresses will need to be listed in a separate document. These directors will serve on the board until the first annual shareholders’ meeting, when a new board will be elected.

One of the new corporation’s most important tasks is to prepare minutes for the first board of directors meeting. This first meeting is where several key company actions should be approved, such as electing officers, adopting bylaws, selecting the main office or headquarters location, choosing a bank for corporate accounts, the accounting period or fiscal year, initial tax elections, and issuance of initial shares of corporate stock. Normally the groundwork and supporting research is done before the actual meeting, although the board can change or amend the minutes as prepared if they vote to do so. Any of the initial directors can prepare the minutes, but the entire board must sign them at the meeting, incorporating any amendments or changes as needed.

Thereafter, at a minimum, the corporation must hold a shareholders’ meeting and a board of directors meeting at least annually; accurate, complete minutes for both are essential, because these documents will be used as reference materials for future decisions. Remember: “If it’s not written down, it didn’t happen.”

A limited liability company, on the other hand, comes officially into being when its articles of organization are filed with the state’s LLC office. The articles contain basic organizational information about the LLC, such as its name; whether it’s managed by its members or by selected members called managers; the name and address of its members; and where its office is.

Next to its articles of organization, the most important document for an LLC is its operating agreement. This isn’t required by the state (except for New York)—but it’s a key internal document that officially records how the LLC will run. It is very much the same as a partnership agreement; except for an LLC it is called an operating agreement. It lists the members, how much each member has invested, how profits will be divided, and how much weight each member has when matters come to a vote. It may also specify requirements for meetings (notice, quorum, voting rules, etc.) and the like, but it doesn’t have to. Normally, however, the operating agreement does include state-mandated requirements.

External Requirements

External requirements usually consist of a periodic report to the state and some kind of fee. Most states require corporations and LLCs to file an annual or biennial statement or report, along with an associated filing fee of some kind. LLCs may also be liable for payroll tax, property taxes, sales and use taxes or “seller’s permits,” or business license renewals. Other state or local filings, such as business licensing or state or municipal tax registrations, may also be required. Owners will also still file their individual state and federal income tax returns.

Some states also impose a franchise tax—basically a fee paid by the company for the state’s permission to operate there. Different states use different methods to calculate the franchise tax; it may be based on revenue, or on some measure such as a corporation’s total number of authorized shares and their value.

Each state has its own deadlines for annual statements and franchise taxes. Some states determine these based on the formation anniversary of the corporation or LLC. Other states set one deadline for annual statements for all corporations and another for all LLCs. Business owners need to know how and where to research these requirements so that they can plan for them before incorporating, and then keep up with changing requirements as their business continues to operate and progress.

Copyright Notice: Guests of IncFile.com’s website may not copy, republish, or redistribute information or material from its website in any form, printed or electronic, without the express written consent of IncFile.com. Requests for use of copyrighted material from the IncFile.com website should be directed to support@incfile.com.

Unlike a for-profit Corporation, a Nonprofit Corporation is not designed to make a profit for shareholders. Instead, it is established for a specific noncommercial purpose, such as educational, literary, charitable, religious, or scientific, for example. None of the income of the organization gets distributed to its officers or directors. Some common examples are schools, colleges, universities, hospitals, houses of worship, museums, fraternal organizations, homeless shelters, food banks, and other volunteer organizations.

Nonprofit Corporations may be eligible to benefit from not having to pay corporate taxes on income they receive that is related to their stated purpose. This tax-exempt status, if obtained, means that donors may be able to deduct their donations to your Nonprofit Corporation on their federal and state income tax returns. This can be a requirement to qualify for a variety of private and public grants. And, just like a for-profit corporation, members and directors of nonprofits are generally protected from personal liability for the operation of their Nonprofit Corporation, which is not true for an unincorporated association or club, no matter how noble the cause.

Unlike regular corporations, however, a nonprofit corporation cannot distribute any profits to its members, contribute money to political campaigns, or engage in lobbying activity, except in very limited circumstances.

The most commonly-used federal tax exemption used for nonprofit corporations is in Section 501(c)(3) of the Internal Revenue Code. This is why Nonprofit Corporations are often referred to as “501(c)(3) organizations” or even just “501(c)(3)s.”

To achieve that critical tax-exempt status, though, nonprofits must apply for federal and state tax-exempt status; it is not just automatically granted by forming the Nonprofit Corporation. To apply for federal tax-exempt status, IRS Form 1023 must be filed with the IRS, and the appropriate tax-exempt application made at the state level as needed.

Like standard for-profit Corporations, Nonprofit Corporations provide limited liability protection for their officers, directors, and members, so that their bank accounts, homes, and other personal assets typically can’t be used to satisfy the debts and liabilities of the Nonprofit Corporation.

Even though Nonprofit Corporations are established and regulated under different state laws than standard for-profit Corporations, the process of forming a nonprofit is fairly similar.

Choose a Business Name
Generally speaking, your Nonprofit Corporation’s name can’t be the same or confusingly close to another, already-registered Corporation, and can’t contain certain potentially misleading words or terms (like Federal, National, Bank, United States, and the like). Some states also require a corporate designator at the end of the name, such as “Corporation” (Corp.), “Incorporated” (Inc.), or “Limited” (Ltd.). There are many states that require a corporate designator with for-profit Corporations that do not require designators for Nonprofit Corporations.

Once you have decided upon a name and entered your information online, IncFile.com automatically performs a name search against the corporate database of the state of incorporation to check the availability.

Nonprofit Articles of Incorporation
In order to actually form your Nonprofit Corporation, you will have to file Nonprofit Articles of Incorporation with the appropriate state agency and pay the necessary state filing fees (usually fairly small). In some states, this may be called a Certificate of Incorporation, a charter, or a Certificate of Formation.

Regardless of what they are called, the formation documents need to include specific information and language to make sure you’ll qualify for tax-exempt status. IncFile.com automatically includes the necessary verbiage required by the IRS for 501(c)(3) status.

Apply for Tax Exemptions
After your state’s corporate filing office returns a copy of your filed articles, you can submit your federal 501(c)(3) tax exemption application to the IRS. This has to be done in this order because the IRS requires you to submit a copy of your filed articles with your application. This is a crucial step in forming your nonprofit, since most of the real benefits of being a Nonprofit Corporation are dependent on gaining 501(c)(3) tax-exempt status. The application fee ranges from $300 to $750.

After the IRS reviews your application, it will send you a letter approving your nonprofit tax-exempt status, asking you for more information about your organization, or denying your application outright if it doesn’t meet required standards. If that’s the case, the IRS will tell you where the shortfall was; this is often correctable by including more specific or precise language in your application.

In some states, you will need to apply separately to get a state tax exemption. In other states, as long as you file nonprofit articles of incorporation with the state and get your federal 501(c)(3) tax-exempt status, your state tax exemption will be automatically granted, or will be granted once you furnish a copy of the IRS approval.

Bylaws
After filing your Articles of Incorporation and tax-exempt applications, it’s time to create your corporate bylaws, which lay out your nonprofits’ purpose and internal operating rules. These should include:

* How directors are elected and what authority they have.
* How, when, and where directors’ meetings are held.
* How decisions can be reached with or without a meeting.
* The duties and responsibilities of officers and how long they serve.
* Officers, constituency rights and responsibilities, and standing committees.
* The organizational structure of the nonprofit.

To create your Nonprofit Corporation bylaws, you can hire a corporate attorney—or you use IncFile.com’s nonprofit incorporation kit. Bylaws are typically adopted by the corporation’s directors at their first board meeting.

Appoint Directors
The next step is to appoint an initial group of directors. The directors of the Nonprofit Corporation have the overall authority and responsibility to manage and run the organization. Collectively, they meet periodically and make decisions about major business operations. Many states allow nonprofits to have just one director, but other states require at least three. The board is ultimately responsible for setting the vision and direction of the organization and providing oversight.

In most states you must designate your initial directors when filing your Articles of Incorporation. These directors will serve on the board until the first board of directors meeting, when the first elected board will be seated.

Hold a Meeting of the Board of Directors
The initial makeup of your Nonprofit Corporation board of directors may or may not change at the first board meeting. What’s important to notice is that the first slate of directors is appointed, and then from there on they are elected.

Normally a corporation’s officers include, at a minimum, a president, treasurer, and secretary, or their functional equivalents. It may be “Chief Executive Officer” instead of “president,” for instance, or “Chief Financial Officer” instead of “treasurer.”

The purpose of this first, organizational meeting of the board of directors is where several significant company actions should be approved, such as electing officers, adopting bylaws, selecting the main office or headquarters location, choosing a bank for corporate accounts, designating the accounting period or fiscal year, initial tax elections, and documenting the receipt of federal and state tax exemptions.

Officers (who may also serve on the board) carry out the day-to-day business of the corporation and sometimes do receive salaries.

Depending on its structure, a nonprofit may or may not have formal members with voting rights. If your nonprofit doesn’t create a formal membership structure, the only people who participate in the management of the nonprofit operations are the directors and officers.

After the meeting is completed, minutes of the meeting should be created and filed in your corporate records book.

Acquire Licenses or Permits
Many businesses, whether operating as for-profit or Nonprofit Corporations, are required to obtain state or local licenses and permits before starting to conduct business operations. So, while your organization may not be subject to the kind of red tape that can entangle for-profits, you should check with your state department of consumer affairs (or similar state licensing agency) for information about any licensing or permit requirements for your type of organization. For instance, a local business license (sometimes called a tax registration certificate) may be required for your activities, and if you sell anything to consumers, you may need a state sales tax permit or license.

Small business owners are especially at risk of stumbling into this particular pitfall. Since they are often overwhelmed with the multiple facets of their business’ day-to-day operating needs, they may not know how to avoid noncompliance and the resulting crippling or fatal business consequences. IncFile.com can help.

Corporations and LLCs have both internal and external ongoing requirements. The internal requirements must be met by the directors of the corporation or the members of the LLC, and then documented in company records. External requirements are those imposed by the state in which the LLC or corporation was formed; these often include, at a minimum, an annual (every year) or biennial (every two years) filing with the state, as well as some kind of fee.

Internal Requirements

Internal requirements are frequently overlooked, but are vitally necessary to effective decision-making and communication within the organization. A corporation has more internal requirements than an LLC; these include holding and properly documenting director and shareholder meetings, adopting and updating bylaws, issuing stock to shareholders, and recording stock transfers. While these actions are not specifically required for an LLC, it’s still a good idea to adopt an operating agreement (and keep it up to date with amendments as needed), issue membership shares, record interest transfers, and hold annual meetings.

Owners use a consolidated corporate records book to organize and maintain important corporate documents such as articles, bylaws, meeting minutes, resolutions, stock certificates, deeds, and so on. Many business owners use a Corporate Kit or LLC Kit for organizing and maintaining these vital records. Many businesses also use a metal or rubber corporate seal—the kind that leaves the company name in raised letters on a document—to signify that the document is an authorized, official transaction of the corporation. These can be obtained as part of a corporate kit or from a stationery store.

Bylaws lay out the corporation’s basic operating principles; they should be planned for and drawn up as part of the incorporation process. It is not required to file the bylaws with any government agency, but a corporation is required to have at least an initial and annual meetings, adopt bylaws, and keep minutes of the meetings, and keep these on file with the corporate records. Bylaws are important because they set down formal rules for such things as: when and how meetings can be held; notice, quorum, and voting rules for meetings; how decisions can be reached and recorded outside of meetings; basic titles and responsibilities of corporate officers; and the requirements for providing periodic (usually at least annual) information to shareholders.

In short, bylaws are the corporation’s major decision-making and operating procedures set down on paper. This can help owners refine and improve their common practices, and can also serve as a “referee” when uncertainty or disagreements arise on what the official solution is to a given situation or need. Bylaws also give your firm credibility in the eyes of shareholders, creditors, potential investors, other businesses, and even the IRS. Owners should take care, though, to make sure their bylaws do not conflict with their state’s Business Corporation Act or its equivalent.

If the board of directors is not already appointed in the articles of incorporation—a requirement in some states—the initial board’s names and addresses will need to be listed in a separate document. These directors will serve on the board until the first annual shareholders’ meeting, when a new board will be elected.

One of the new corporation’s most important tasks is to prepare minutes for the first board of directors meeting. This first meeting is where several key company actions should be approved, such as electing officers, adopting bylaws, selecting the main office or headquarters location, choosing a bank for corporate accounts, the accounting period or fiscal year, initial tax elections, and issuance of initial shares of corporate stock. Normally the groundwork and supporting research is done before the actual meeting, although the board can change or amend the minutes as prepared if they vote to do so. Any of the initial directors can prepare the minutes, but the entire board must sign them at the meeting, incorporating any amendments or changes as needed.

Thereafter, at a minimum, the corporation must hold a shareholders’ meeting and a board of directors meeting at least annually; accurate, complete minutes for both are essential, because these documents will be used as reference materials for future decisions. Remember: “If it’s not written down, it didn’t happen.”

A limited liability company, on the other hand, comes officially into being when its articles of organization are filed with the state’s LLC office. The articles contain basic organizational information about the LLC, such as its name; whether it’s managed by its members or by selected members called managers; the name and address of its members; and where its office is.

Next to its articles of organization, the most important document for an LLC is its operating agreement. This isn’t required by the state (except for New York)—but it’s a key internal document that officially records how the LLC will run. It is very much the same as a partnership agreement; except for an LLC it is called an operating agreement. It lists the members, how much each member has invested, how profits will be divided, and how much weight each member has when matters come to a vote. It may also specify requirements for meetings (notice, quorum, voting rules, etc.) and the like, but it doesn’t have to. Normally, however, the operating agreement does include state-mandated requirements.

External Requirements

External requirements usually consist of a periodic report to the state and some kind of fee. Most states require corporations and LLCs to file an annual or biennial statement or report, along with an associated filing fee of some kind. LLCs may also be liable for payroll tax, property taxes, sales and use taxes or “seller’s permits,” or business license renewals. Other state or local filings, such as business licensing or state or municipal tax registrations, may also be required. Owners will also still file their individual state and federal income tax returns.

Some states also impose a franchise tax—basically a fee paid by the company for the state’s permission to operate there. Different states use different methods to calculate the franchise tax; it may be based on revenue, or on some measure such as a corporation’s total number of authorized shares and their value.

Each state has its own deadlines for annual statements and franchise taxes. Some states determine these based on the formation anniversary of the corporation or LLC. Other states set one deadline for annual statements for all corporations and another for all LLCs. Business owners need to know how and where to research these requirements so that they can plan for them before incorporating, and then keep up with changing requirements as their business continues to operate and progress.

Copyright Notice: Guests of IncFile.com’s website may not copy, republish, or redistribute information or material from its website in any form, printed or electronic, without the express written consent of IncFile.com. Requests for use of copyrighted material from the IncFile.com website should be directed to support@incfile.com.

And while Limited Liability Companies are a newer entity type than C-Corporations, they offer unique differences that the C-Corporation cannot provide (and vice versa), and in recent years have often become the entity type of choice for newer and smaller businesses.

One of the primary differences between the two is from the taxing standpoint. C-Corporations are subject to corporate income taxes that are completely separate from their owner(s). Because of this, C-corporations have a greater and more complex tax reporting responsibility than most companies.

This differs from an LLC, which passes profits through to the owner(s), who are then subject to only personal income tax (i.e. The LLC does not pay federal income taxes to the IRS, unlike a C-corporation). This helps avoid double taxation, which C-corporations may have to face if they pay dividends to their shareholders (the corporate income is taxed, and then, if the net income that is left after taxes is distributed to the shareholders, it is then taxed at the personal level at the prevailing dividend tax rate.

While this may seem like an advantage for an LLC, that is not always the case. Because of the Pass through” of profits, LLC owners must pay self employment taxes on profits in addition to their personal income taxes.

A second major difference between LLCs and C-Corporations is that of the ownership structure.

C-Corporations have sort of a hierarchal structure. Power is divided between stockholders, who then hire/appoint directors that make the overall decisions for the corporation, who in turn hire/appoint officers to run the day to day operations of the company. Stockholders with more shares are rewarded with more voting influence and profits.

While this is a standard for most C-corporations, it is not the case with an LLC.

LLCs are structured essentially like a partnership (or a sole proprietorship in the case of a single member/married couple LLC), but with the limited liability protection, similar to a corporation. Members (the generic term used for the owners of an LLC) run the company and make all decisions. The division of ownership, as well as the distribution of the profits (which may be the same or different from the distribution of ownership) as well as most other matters are decided by private agreement amongst the owners.

With an LLC, the owners make the rules in regards to profit distribution and power. A 5% shareholder could reap larger profits if the other owners deem it fair. Thus, and this is in general terms, LLCs are typically a better choice for smaller companies where only a few principals and workers are involved.

Also, an LLC doesn’t need multiple owners to exist; only one member is required in order to have an LLC by all states.

LLCs are also not required to hold corporate and shareholder meetings, which are a requirement for C and S Corporations.

They both have their distinct uses. In general terms, a C-Corporation may be a better choice for a larger entity with more shareholders, and it is also the best choice if there are plans to of equity ownership to a larger number of owners, whether in terms of private placement or taking the company public and having it listed on a stock exchange.

However, this also means a tiny C-corporation stockholder who contributes beyond his or her percentage of ownership will not be rewarded anything beyond what he or she would have normally received (unless the shareholder is compensated with salary or bonuses).

While quite similar in many respects, LLC’s and S-Corporations both have advantages over one another.

For example, while LLCs and S-Corporations share the same “separate entity” status enjoyed by corporations (meaning the company is a separate entity from its owners), the profits and voting power are not necessarily allotted the same way.

An S-Corporation divides profits between its shareholders evenly. Someone with 30% of the stock would receive 30% of the profits while another with 10% of the stock would receive 10% of the profits, and so on.

This is not the case with the LLC. In an LLC, the members (akin to stockholders, although LLC’s usually issue “member units” as opposed to common stock) decide how profits should be divided. There may be someone with 10% of the “stock”, but they put in 30% of the work. This stockholder can receive more than what they have invested if the other members agree that they deserve it.

The same goes with voting power. S-Corporations follow a more traditional structure by which voting power is determined by stock ownership. An LLC can give more or less voting power to stockholders regardless of how much stock they may own.

Also, there are several other abilities an LLC has that do not apply to S-Corporations.

LLCs:

* No ownership restrictions – virtually anyone (individuals, Corporations, other LLC’s, and even foreign entities may be owners of an LLC).
* Can operate with a single member.
* Are not required to hold annual meetings.

An S-Corporation has separate ownership provisions. The S-Corporation is limited to 75 shareholders all of which are required to be US citizens. They are also required to hold shareholder and corporate meetings, which can affect record-keeping needs and continuity within a company.

LLCs sound pretty good, right?

Well (and you knew this was coming), there are some down-sides too.

For starters, S-Corporations get better deductions in regards to benefits (health insurance, etc.)

The status of the pass through income is a little different as well for the personal service principals (the principals that are employees.) It is considered “passive income” and not “earned income (like it is with an LLC.) Thus, Social Security and Medicare taxes (at this writing) are not levied.

In addition, LLC’s may have a limited shelf-life. Some states have a cap on how long they can stay in business (30 years, etc.)

In closing, you could say that S-Corporations allow for more shareholder uniformity and tax savings, while an LLC allows more free negotiations and possibilities for ownership and accountability. You can almost think of an LLC as a marriage between a classic small business (partnership / sole proprietorship) and a corporation.

An operating agreement is a contract among the LLCs members stipulating its membership, management, operation, and the distribution of the company’s income. It documents the roles, responsibilities, rights, and relationships of the members, as well as their respective ownership percentages, shares of profits and losses, and what will happen to the LLC if someone leaves or if a new member wants to come on board. Not only does this increase your organization’s efficiency and effectiveness, it also helps prevent disagreements and misunderstandings about decision-making and financial dealings.

The Incfile.com LLC Kit has a customizable operating agreement that can be customized to meet the particular needs of your LLC.

Having an operating agreement also gives your LLC credibility as a separate entity, especially when it comes to the legal system. It helps safeguard your limited liability status, so it is a smart idea even if you are the sole owner of your company. If you are a single member LLC but do not have a formal operating agreement, the court may not respect your limited personal liability and may view your operation as a sole proprietorship instead, opening you up to significantly increased financial and operational risk.

Documenting your LLC’s procedures in an operating agreement also allows the members to set the rules, instead of being forced to follow your state’s default rules – which might or might not be a good fit for your particular business. Each state has its own laws governing basic operating procedures for LLCs. In some areas, these state default rules will be the controlling factor in how your business runs unless your operating agreement specifies different rules.

Some states, for instance, have a default rule that requires LLC members to divide profits and losses equally, regardless of the level of each member’s investment in the business. If all members did not invest equal amounts in the LLC, it’s unlikely that all members will want to allocate the profits equally. To avoid this, your operating agreement should spell out how you and your fellow members (sometimes called co-owners) want to split profits and losses.

Another area that your operating agreement needs to cover in detail is how ownership shares are distributed. The members/owners of an LLC usually contribute cash, property, or services to the business to help get it started. In consideration of this, each LLC member gets a percentage of ownership in the LLC—usually in proportion to their contributions, but LLC members are free to divide up ownership any way they want to.

As well as getting a percentage-based ownership interest in exchange for their contribution of capital, LLC co-owners each also receive shares of the LLC’s profits and losses, called distributive shares. Each owner’s distributive share usually corresponds to his or her percentage of ownership in the LLC.

The operating agreement should also specify how much of the LLC’s allocated profits will be actually distributed to the members each year. It’s important to remember that an LLC member has to pay income taxes on the full amount of the profits that are allocated to him by the distributive shares specified in the operating agreement, whether or not those profits were actually paid to the member.

Since LLCs usually have relatively few members, most management decisions are made informally. Sometimes, however, a decision is so significant or contentious that a formal vote is necessary. While some LLCs allot one vote per member regardless of shares – called per capita voting – it’s more common for each member to control votes proportionate to his or her shares in the business. The operating agreement should also specify whether a simple majority will decide voted questions, or whether unanimous consent is required.

The paradox is that the more well-thought-out your operating agreement is—the more contingencies and possibilities it covers – the more complex it is, not to mention longer. This article has mentioned only the highlights of what an LLC needs to cover; specific requirements will depend on the laws of your state and exactly how you want your business to operate. Again, the LLC Kit will answer your more detailed questions.