Inc. vs. LLC: Which legal structure suits your business?
By Jenny C. McCune • Bankrate.com

There's more to starting a business than coming up with a great idea, writing a business plan and finding financing. A would-be small-business owner also must decide how the business should be structured.

Until recently, most chose between sole proprietor, partnership and incorporation (including its small-business sibling, the S chapter corporation).

Now, though, more business owners are choosing to go with another choice -- the limited liability company. An LLC offers more legal protection than a partnership, but retains the tax pass-through characteristics of a partnership.

Like the other choices, it has its pluses and minuses. Although individual circumstances will affect your decision, here's a scorecard for each that should help you plot your course.

LLCs
"Most people think that LLCs are probably the wave of the future," says Mark Luscombe, principal analyst for the federal and state tax group at CCH, an electronic and print publisher of tax and business legal information. "It's gradually supplanting other forms, except for companies that eventually are interested in going public."

Advantages: LLCs, like corporations, provide business owners with liability protection. That is, debtors will go after company assets, not your personal assets. That's a step up from partnerships and sole proprietorships when your personal assets may be used to settle a business debt. Unlike corporations, LLCs don't suffer from double-taxation, in which the corporate entity is taxed and then its shareholders' dividends are taxed as well. This benefit applies to LLCs that are classified as partnerships for tax purposes. An LLC tax preparer simply checks a box on his or her federal return to indicate how the organization will be taxed. Some states' tax laws mirror the federal government's treatment of LLCs.

Earnings and losses pass through to the owners and are included on their personal tax returns. There's also less paperwork involved with running an LLC than a formal corporation: "No year-end minutes, no notification of shareholders of meetings and so on," says Dan Zabludowski, a partner with the law firm of Litow, Cutler & Zabludowski, an LLC with offices in Coral Gables and Fort Lauderdale, Fla.

Finally, LLCs are the most flexible when it comes to organization. For example, there are fewer rules regarding who can be a shareholder. They also tend to be more informally run than a regular corporation.

Disadvantages: Tax liability for an LLC varies by state. So if your company is going to operate in several different states, you'll have to know how they treat LLCs before electing to choose this type of corporate structure. An LLC also can't go public, so if you're the owner of a dot-com that envisions an initial public offering down the road, incorporation is a better route to take. Otherwise, you'll have to switch your company from being an LLC to being a corporation. That can add to the cost of your IPO.

Lawyers, who are less familiar with the newer LLCs than regular incorporation, also may charge more for helping you form an LLC than another corporate structure.

The cost of launching an LLC also varies by state. Some states charge more for a LLC than to incorporate, some charge less and some charge the same rate regardless of what form of corporate structure that you choose. A few states even charge special annual fees for LLCs. Finally some states require two or more partners for an LLC so if you're going into business solo, this business format is not for you.

Incorporations
A new business can form a C corporation or an S corporation. According to some press reports, the number of S corporations that are sprouting is actually surpassing the formation of C corporations in part because of the advantages inherent with S corporations. Most businesses just starting out will opt for the S classification.

Advantages: Unlike LLCs, both S corporations and C corporations can go public. For that reason, venture capital companies prefer to work with corporations rather than with LLCs. S corporations, like LLCs, don't suffer from double taxation. C corporations may face double taxation, but they can have incentive stock option plans.

Disadvantages of corporations: As mentioned previously, C corporations face double-taxation, but S corporations also have drawbacks. Their chief disadvantage is that the number of shareholders that an S corporation can have is capped at 35, according to Zabludowski.

Both S and C corporations require more ongoing paperwork than an LLC. They must file articles of incorporation, hold directors' and shareholders' meetings, keep corporate minutes and hold shareholder votes on major corporate decisions.

Which is right for you?
Sitting down with your attorney and your accountant is probably the best way to sort through the tax and organizational ramifications and figure out what's right for your company. That said, there are ways to cut corners.

If you feel competent, you can incorporate your business or form an LLC on your own. It requires checking with your state's corporate filing office (usually the Secretary of State or the Corporations Commissioner) and filling out forms available at the filing office or available from commercial publishers. For business tax and licensing information about your state, go to Bankrate.com's state-by-state list.

There are also Web sites such as Corporate Agents, CorpAmerica and Business Filings that promise to make business formation a matter of filling in the blanks. However, if you have any doubts or your business organizing takes a complicated turn because you'll be selling stock, etc., don't go it alone -- enlist the aid of professionals. Filing incorporation papers should cost between $200 and $1,000, depending on your state, according to the Nolo Press, publisher of do-it-yourself legal guides.

You'll also need to check with federal and state trademark registries to determine whether the name you've chosen for your company is available. Business owners who are seeking to incorporate will also have to complete corporate bylaws, which outline when the annual shareholder meetings will be held, who can vote, how shareholders will be informed if there's a need to additional meetings, and so on.

Build a good foundation by selecting the right structure for your company and your fledgling concern will get off to a great start.

Jenny C. McCune is a contributing editor based in Montana
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-- Posted: Aug. 31, 2000