Written By:Scott Glatstian
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More Americans are seeking entrepreneurship, according to the National Federation of Independent Business (NFIB). A study indicated that small business optimism sat at 99.7% in July of 2021, despite ongoing concerns about finding employees, supply chain issues, and inflation. Still, becoming an entrepreneur is an exciting time in a person’s life.
When taking a big step into business ownership, figuring out what business structure to use is an important consideration. It can be tough to choose between forming an LLC or a corporation. Both are good, but the key is figuring out how your business might fit into each model and which will actually work best. This article will help you understand both organization types, the pros and cons of each, and the legal issues that may cause someone to lose the liability protection of these business formations, such as when court “pierces the veil” of a business and goes after it’s owner because of how the business was operated.
What Is a Corporation?
A corporation is a business structure that makes the company a separate entity from the owner. The business entity will be able to own property, pay its taxes, enter into contracts, and be responsible for its debts. A corporation is usually created when it is incorporated by a group of shareholders, these people share ownership by holding a percentage of stock in the company. A main aspect of a corporation is that it provides for limited liability. For shareholders, this is great because they can profit from the company without being personally responsible for the company’s debts.
There are three types of corporations to choose from: C-corporation, S-corporation, and non-profit corporation.
C-corporation: This business structure separates owners’ or shareholders’ assets from the corporation. The owners that receive profit from the business are taxed on an individual level. The business is taxed as an entity. This structure is mandated by law to have annual meetings. They also must have a board of directors. Those directors are voted in by the shareholders of the company. The C-corporation is a common form of incorporation.
S-corporation: In an S-corporation, taxes and owners are handled differently. Shareholders in S-corporations must have no more than 100 shareholders to qualify as S-corporations. When it’s time to do taxes, shareholders report the profits or losses on their tax returns.
Non-profit corporation: Many people are familiar with non-profits. This model is mostly selected by charities, educational organizations, and religious organizations. These businesses are not taxed and any money that is received is used for the organization’s purpose.
How to Set Up a Corporation
To make a business a corporation, a person must file an article of incorporation, which is a set of documents that are filed with the Office of the Secretary of State in the state in which you live. The states may have different laws, and the filing fee may be different depending on the state. It’s always good to consult a lawyer to walk you through the laws before filing the documents.
The article of incorporation will require information. The documents should include:
- Name of the corporation
- Name and address of the registered agent
- Structure of the corporation
- Names and addresses of the initial board of directors
- Number and type of authorized shares
- Name and signature of the person who is in charge of setting up the corporation
What Are the Pros and Cons of a Corporation?
Knowing if a corporation is a good fit for your company requires weighing the pros and cons. You should keep in mind what you want the business to be, whether it is a charity or a for-profit business, and if you want shareholders or not. As you weigh this decision, keep all of this in mind.
|Its own entity: It is separate from the owners. The entity can operate contracts, buy property, etc. The business is responsible for its own debts.||Cost of incorporation: The process can be expensive depending on the state.|
|Limited liability: People are only liable for the amount they contributed.||Documentation: These companies must file annual reports and tax returns. They must keep exceptional records.|
|Management: The shareholders and owners do not directly have to run the daily operations. The board of directors can hire outside management.||Less flexibility: Although a board of directors can be great, this may not be the best option for someone who wants to retain control.|
|Board of directors: Having a board is a great way to maintain accountability for the company. The board can vote on decisions for the company; it’s not a dictatorship.||Double taxation: If the company is a C-corporation, there will be two taxes. One for the business and another that shareholders will pay on their income.|
|Investors: It will be easier to attract investors to the company because of the taxation process for corporations.|
While it’s good to weigh the pros and cons on your own, it’s also advised to seek legal help. An attorney will be able to direct you to the right business model for your unique situation.
What Is an LLC?
LLC stands for limited liability company. Limited liability in the company means the owners are protected from personal liability on behalf of business debts or claims. If the company has financial issues, creditors won’t be able to come for the owner personally. Taxes for LLCs aren’t separate from their owners. Any gains or losses go directly to the owners and those are reported on their individual income tax returns. LLCs don’t require as much paperwork as corporations.
LLCs are under state statutes and the laws will vary from state to state. The owners of LLCs are also commonly referred to as members. Some states don’t restrict members. This means most people or entities can be owners in the LLC, including corporations, foreign entities, foreigners, and even other LLCs.
How to Create an LLC
Both LLCs and corporations have similarities when it comes to filing. LLCs must file an article of organization with the Secretary of State in the state they reside in. To file, a fee must be paid. Other payments may also also be required, depending on the state. The articles establish duties, liabilities, rights, and powers among the members of the LLC. Although information for articles of organization will vary based on state, they typically include the following basic information:
- Business Name
- Address of the LLC
- Business purpose
- Members/owners’ names
- The registered agent’s information
- The state law: This is the governing law that is specific to the state you reside in. This information sometimes will be preprinted on the document form.
- Effective date: A LLC doesn’t have to be effective the day it is created. If members want the LLC to be effective in the future, they can put an effective date for the future.
What Are the Pros and Cons of an LLC?
An LLC can be a great option for a person seeking a business structure for their company. Understanding the pros and cons can help determine what route to take in finding the perfect business structure fit.
|Simple: LLCs aren’t as complex to run as a corporation. This structure isn’t required to have a board of directors or officers. They also have fewer administrative burdens.||Recognition: Other countries may not recognize what an LLC is. If business is conducted overseas, those countries can tax it as a corporation.|
|Ownership flexibility: There are no restrictions on members/owners. LLCs can have as many or as few as they want.||Ownership transfer: It’s harder to transfer ownership of an LLC than for a corporation. For an LLC, all members must approve bringing on a new member into the group.|
|Personal protection: Because of its limited liability statutes, the owners are protected from the downfalls of the company (If any occur).||Cost: If you are a sole proprietorship or a partnership business model, the cost of switching to an LLC can be more costly.|
|Taxes: Unlike a corporation, there isn’t any double taxation. The profits or losses go straight to the members and they report that on their taxes.||Investors: Investors commonly stick with corporations, especially venture capitalists. Investors find corporations’ laws more beneficial when it comes to investing.|
|Control: There is more flexibility in how the members run the business. They can be a part of daily operations. They can have managers run the business and those managers can be non-members or members. Sometimes they will be both.|
Consulting an attorney about becoming an LLC is important. They can give you an in-depth look at the pros and cons of establishing an LLC, and help you determine if it’s the most suitable business model for your company’s future needs.
Piercing the Veil
Piercing the veil is when the courts decide to disregard the corporation or LLC as a separate entity, which will then make the owner liable for business debts. Unfortunately, businesses will sometimes face financial hardships. Creditors will sue to regain unpaid debts. In most scenarios, the creditors will sue the company for unpaid debts. If the company is unable to pay and a court has “pierced the veil” separating the company from its owners, then shareholders or members will be sued for these debts. A court may pierce the veil on a company for a few reasons, such as:
1. Proof that the company and owner’s financial state isn’t separate:
When the company’s financial obligation isn’t clearly unconnected from personal financial commitment, it can work against the owner. An owner who uses a company bank account to pay personal bills or deposits checks that are meant for the company into their personal bank account are all signs of non-separation. The same holds true in reverse. If the owner uses personal funds to pay for company expenses, it may indicate a lack of separation between the company and the owner. Anytime ownership appears to commingle assets or act in a way that blurs the line between personal assets and company property, a court may find that the company is little more than a holding place for the owner’s assets, and this may result in a loss of any liability protection that may have come from forming the company.
2. If a company is fraudulent:
When a company shows signs of engaging in fraud, the behavior will put it in jeopardy of piercing the veil. Breaking any business laws and defrauding consumers or businesses are fraudulent behaviors.
Being aware of what makes you susceptible to piercing the veil is essential. A case in Iowa is an excellent example of why it’s important to follow the rules, especially with regard to keeping business and personal finances separate.
Woodruff Construction sued Clark Farms and the owner, Clark, for breach of contract. The construction company later asked for the veil to be pierced to hold Clark accountable. Woodruff hired Clark’s company to remove lagoon sludge for the construction company. However, after starting the job, Clark Farms abandoned it. So, Woodruff sued and obtained a judgment of over $400,000 dollars. When Woodruff couldn’t collect from the company, it asked to pierce the veil.
Woodruff won because there wasn’t a clear distinction between company and personal finances. Clark used corporate funds to pay personal bills and debts. A lack of financial documentation was also a factor in the case. As a result, Clark was held responsible for repaying the funds to the Woodruff Construction.
If you’re concerned about how your company is structured or have questions about whether you may be open to liability despite forming an LLC or corporation to shield your personal assets, it’s worth speaking with an attorney who can review the situation and let you know where you stand.
Where to Find Help
An entrepreneurial spirit is a great attribute. Starting a business can be fun, but it’s also challenging. Hiring an attorney to decide on a model for your business is wise. They will also be able to help you foresee legal hurdles that might arise in the future. The attorneys at Rosenblum Law have years of experience working with clients to establish and litigate issues associated with running a business. Contact us today for a free consultation.
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How to Cite Rosenblum Law’s Article
Scott Glatstian (Jul 25, 2022). Estate Planning Is About Helping Your Family. Rosenblum Law Firm, https://rosenblumlaw.com/estate-planning-is-about-helping-your-family/
Scott Glatstian "Estate Planning Is About Helping Your Family". Rosenblum Law Firm, Jul 25, 2022. https://rosenblumlaw.com/estate-planning-is-about-helping-your-family/