Is an LLC a Corporation? a Los Angeles Primer for Business Law
Forming a business and navigating compliance across state and federal regulations can seem overwhelming to a first-time entrepreneur4 min read
Forming a business and navigating compliance across state and federal regulations can seem overwhelming to a first-time entrepreneur. In cities like Los Angeles with a thicket of business regulations, it’s essential to understand all of the risks and benefits of a particular business structure, such as whether an LLC is a corporation.
A limited liability company, or LLC, is a recognition of a business that’s distinct from its owners. Since the business and its owners are legally separate, the LLC framework protects members from personal responsibility if the business incurs debt or faces lawsuits. Crucially, LLCs are not corporations, and that distinction can have a profound impact on a business’s operations and taxes.
What Is an LLC?
An LLC is a business entity recognized by both state and federal governments. Depending on the state, LLCs may be subject to taxes, fees, and special regulations that vary from other types of business structures like corporations, partnerships, and sole proprietorships.
An LLC itself doesn’t pay taxes because it’s not actively participating in business activities. Instead, it’s the members who pay taxes if the business has profited. These members, however, don’t pay taxes on their personal income. Instead, they pay taxes on the earnings from the LLC, usually in the form of an income tax and, in California, the LLCs are required to pay an annual tax of $800 to the California Franchise Tax Board.
Under the LLC framework, the business’s assets and liabilities are officially distinct from its owners. This framework allows LLC members to avoid personal responsibility and financial loss in the event that the business experiences financial trouble or faces legal action.
What Is a Corporation?
A corporation differs from an LLC in several ways. Though both business entities are officially recognized by both state and federal governments, corporations are considered legal citizens and are obligated to pay taxes on their earnings. This feature is called “double taxation,” as corporations must also pay taxes on their income before distributing capital to shareholders.
While LLCs only have to file an annual tax return on behalf of their members, corporations must file several tax documents with the state and federal governments. Additionally, corporations usually require bylaws that outline how the entities will carry out their business activities, who will manage the operations of the business, and how profits will be allocated.
To form a corporation, members must record the articles of incorporation with the state where the company is based. This document provides registration information, such as the name of the business, its stated purpose, and the eligible number of shares it will issue to shareholders.
Another aspect of this legal recognition is that corporations are considered responsible for their actions. While members of an LLC are considered distinct from the business, shareholders in a corporation are partly responsible for debts incurred by the business and have the risk of being sued if something goes wrong.
How to Choose Which Business Structure Is Right for You
Choosing and forming a business structure is a crucial step for entrepreneurs. Although it’s always a good idea to consult an experienced business attorney, here are some essential questions to consider when making your decision.
1. Is the business profitable?
If the business is expecting to make more than $50,000 or more in annual profits, an LLC can provide individual members with more control over their taxes. If the business can’t establish a fixed rate of individual taxes, forming a corporation may provide more tax stability for its shareholders.
2. Does the business need passive investors?
In an LLC, all members are actively responsible for the operations of the company. Alternatively, corporations are subject to passive investments that can be made by shareholders, who do not need to be actively involved in the business’s activities.
3. What are the potential tax incentives?
LLCs are taxed differently depending on the amount of members and can benefit from pass-through taxation. This allows members to pay taxes on their individual income rather than on income earned from the LLC. On the other hand, corporations are subject to income taxes, but they can also benefit from deductions on expenses, such as employee wages and travel expenses.
Whether an LLC or a corporation is the better choice for your business depends on specific details related to its operations, taxation, and financial incentives. LLCs are more appropriate for businesses that need personalized control as well as local regulatory advantages, while corporations can be advantageous for larger-scale enterprises with passive investors.
Forming any new business is a complex endeavor in Los Angeles, and there are many factors to consider. If you’re considering transitioning to a different business structure, it’s important to seek advice from business attorneys experienced in the nuances of local regulations. UpCounsel offers access to a wide network of experienced business lawyers where you can find experienced legal counsel to help you make the right decision.