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Do you know the difference between a corporation and an LLC? I’m often asked which one should I form? I am going to clarify my opinion on how you should answer that question. First off, let’s go back a long ways in time. We’ll talk about corporate law. Corporations were formed and to law based on 1920s 1910s somewhere around there and they were tried and tested within the next 15 to 20 years after that. Then along in the eighties came the new-fangled LLC. LLC is a limited liability company. They’re also limited liability partnerships as well, but we won’t deal with those today. LLCs are a new structure of how a business would operate and they have a whole different set of laws that go behind them. Those laws are established through States. They’re not federal in nature, so they may differ slightly by state. However, the overall structure is the same amongst all States.
Now those formations were in the eighties they were tried and tested in the nineties and even into the early two thousands to make sure that the IRS understood how to deal with them. That took a long time. The IRS developed the check the box regulations and tested those in the late nineties, and those became this the norm. Okay, so now back to our question. If I’m going to form an entity, should I form a corporation or an LLC? I will tell you in my opinion, there’s no reason to form a corporation ever again unless you plan to go public on the stock exchange. And even then, most businesses operate as an LLC up until right before they do an IPO on the stocks. So an LLC is typically the newer way of doing things and a more modern approach to the laws that follow it.
And I’ll give you a very quick example of two reasons why the LLC, in my opinion, is better than a corporation. First off, LLCs have a very distinct difference when it comes to lawsuits. And I hope that this never comes into play for anybody forming an LLC. But in the event you do, it’s a nice piece of insurance. There’s a thing called charging orders. If you personally are sued for something that went wrong, a car accident, some sort of an incident. Who knows whatever people sue for any reason now, but if you have a judgment against you personally, someone can take anything of value that you have. If you own stock in a corporation, let’s say you own some Duke power stock, so Microsoft stock, I can take that. If I hold a judgment against you, now what am I going to do with it?
I’m going to take it, I’m going to liquidate it probably, or I may keep the stock, but I want the money and you no longer will have it. So think of that in terms of your business. If I hold a judgment against you and you own a business that’s a corporation, I will take it. That’s probably your livelihood. That’s your retirement probably. And what will I do with it? Am I going to run your business? Most likely not. I’m going to liquidate it. I’m going to take all the cash. I’m going to sell all the assets. I’m going to sell it and get whatever I can for it and converted to cash you mean? Well, we’ll have no more job, no more livelihood. You’ve lost a business that you’ve grown for years. Now let’s switch gears. Let’s say that that business was an LLC instead of a corporation and in LLC the laws are newer.
They were designed for this timeframe when people sue over everything. So the charging orders for an LLC say that I can take the rights to the ownership of the units of interest in that LLC. However, I cannot take the right to manage it or distribute money or do anything else to it so I can own it. All right? What will that give me? Well, if I can’t sell anything, I can’t liquidate and take the cash. Oh, by the way, I am going to be the one to get the K one statement at the end of the year and pay taxes on the earnings, but I’m never going to get any cash. It is poison to take an LLC and a judgment situation. So it’s a nice form of protection because if you are the owner of that business, you can continue to operate.
Guess what? Even if I decided to take it and I was that dumb, you’ll never distribute a penny of money to me and you’ll probably choose to close it down and reform it in some other way, shape, or fashion. That is not going to be something that me as a judgment holder will like or have any advantage for. So in a judgment case, LLCs provide an extra layer of protection and that nobody wants them. They’re poison corporations. I’ll take it and liquidate it and get whatever I can for it. So I think that alone is the best reason to form an LLC. Secondary in nature is the ability to change how you’re taxed and be very flexible with it. In a corporation, you can be taxed in one of two ways as a C-corporation or an S-corporation, those are the only two. In an LLC, you have the flexibility to be taxed as a sole proprietor, a partnership if there are multiple people, a C-Corp or an S-Corp. So you have flexibility and you can make changes to that every five years. So in the life cycle of your business, if it makes sense to make changes along the way, you have the flexibility to do that while keeping the same entity structure the same federal ID number and name for the business but adjusting the tax situation. So I hope that clarifies for you when you should use an LLC versus a corporation. Good luck and let us know if we can help you in any way.
Donna Bordeaux, CPA with Calculated Moves
Creativity and CPAs don’t generally go together. Most people think of CPAs as nerdy accountants who can’t talk with people. Well, it’s time to break that stereotype. Lively, friendly and knowledgeable can be a part of your relationship with your CPA as demonstrated by Donna and Chad Bordeaux. They have over 50 years of combined experience as entrepreneurial CPAs. They’ve owned businesses and helped business owners exceed their wildest dreams. They have been able to help businesses earn many times more profit than the average business in the same industry and are passionate about helping industries that help families build great memories.