When you decide that it’s time to incorporate your side business, you will need to make a decision about the kind of corporate form you want. The most common choice that you must make is whether to incorporate as a corporation or as an LLC. The corporation has been around for a significantly longer period of time as compared to the LLC, but the LLC has fewer requirements to make it work.
No single solution works for every business. You need to look at your business goals as well as your financial situation to decide which one better suits your needs.
The Best Situations for an LLC
The LLC often works best for small businesses that need something simple and flexible. Regular corporations are generally subject to double taxation, and this makes it harder for small businesses to maintain them.
Setting up an LLC allows you to set up and retain most of the protections of a regular corporation while at the same time avoiding the added taxes. The LLC’s downside is that it does not offer as broad a protection, and the laws are still developing.
In most states, you cannot have shareholders either. The inability to have shareholders does limit the ways that you can raise capital for your business. However, many businesses prefer the fact that LLCs do not have the same heightened formality requirements as a traditional corporation.
The Best Situation for a Corporation
Due to the double taxation, you may wonder why any business would want to incorporate as a regular corporation. The main reason that a business chooses to incorporate as a traditional corporation is so that it can gain shareholders and raise money from the public.
Most of the time, LLCs can only obtain money from investors and debtors. Corporations are structured to raise capital and assist the business in its growth. It also allows for a much greater variety of fringe benefits that vary based on the state through tax deductions and the like.
Corporations are also the only way that a business can have stock certificates legally.
The Best Situation for an S Corporation
In certain qualifying cases, a business may find that it has a third option, the option to incorporate as an S Corporation. The S Corporation avoids the double taxation while also allowing a limited number of stock shares to be sold. The tax incentives can save as much as 15 percent a year, according to Nolo.
The main reason that most businesses do not become S Corporations, though, is because each state has different requirements, and the requirements are often quite strict. In some states, you may be limited in the number of shareholders you can have, the corporate purpose, the activities that the corporation engages in, and more.
You will need to make sure that you do fit all of the standards in your state. If the state determines that you have improperly reported your status, then you run the risk of being penalized.