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LLCs, LLPs, and Corporations: Part 2

LLCs, LLPs, and Corporations: Part 2

By
Michael W. Flynn
January 30, 2009
 
 
First, a disclaimer: Although I am an attorney, the legal information in this podcast is not intended to be a substitute for seeking personalized legal advice from an attorney licensed to practice in your jurisdiction. Further, I do not intend to create an attorney-client relationship with any listener.   
 
Today’s episode is part two of our discussion on the differences between LLCs, LLPs, corporations and sole proprietorships. In last week’s episode, I explained the basic differences among these entities. Now assume you are opening your own bakery. I will discuss the pros and cons of each business entity as applied to opening your bakery.    
 
First, you must create the bakery, and there are two major factors to consider: the fee associated with creating the business, and how much you must pay lawyers to help you create the business. 
 
There are no costs with the state to form a sole proprietorship or LLP. To form a corporation or LLC, you must file papers with the secretary of state. Filing fees for corporations and LLCs, including administration fees, vary from state to state, but will fall anywhere from $50 to $350. Some states will also require every business to obtain a business license or pay a publication fee. 
 
The size and scope of your business will dictate your legal fees. The more complicated the business entity, the more time it will take your lawyer to set you up. A sole proprietorship is the least complicated, LLPs are slightly more complicated, and corporations and LLCs are the most complex. A law firm specializing in startup businesses will charge in the $500-to-$5,000 range for assisting with the incorporation process. The firm can help you fill out the documents necessary for incorporating, explain the process, and review the paperwork you have filled out prior to filing. Legal costs will increase if you have multiple shareholders or complicated shareholder arrangements. The other cost of incorporating is that of paying first-year franchise taxes, which will usually land somewhere between $800 and $1,000.
 
Once you create your bakery, the major consideration is the liability you will incur while operating the bakery. While visiting your bakery, a customer might slip and fall and sue the bakery. Assume that the customer prevails in his lawsuit and wins $100,000. If the bakery is found liable, then the bakery must pay the $100,000. If your bakery has enough assets to pay, then the bakery simply suffers that loss and will continue operating.
 
But, very often the amount of liability will exceed the assets of the business. In this situation, the injured customer might be able to sue you personally. If you operate your bakery as a sole proprietorship, then you are fully liable for any liability the bakery incurs. This liability can be enormous and can throw you into financial ruin. If your bakery is an LLP, then you and your business partners must share the liability. So, you will not suffer quite as large a hit, but are still subject to personal liability.
 
If you form a corporation or an LLC, then you normally limit your liability; the customer can only reach the assets of the bakery, but cannot generally reach your personal assets. So, assume the customer sued for his injury and won $100,000, but your bakery is only worth $50,000. The customer could recover the $50,000. But, the customer will not normally be able to sue you or the other shareholders or members for the remainder. Your liability is normally limited to the amount you have put into the bakery.
 
Next, please welcome Money Girl, who will explain the different tax consequences of each business entity.
 
MG: If you choose to run your bakery as a sole proprietorship (which is not recommended due to the liability exposure Legal Lad told us about), you’d be responsible for paying tax on the income you earned. You’d report business income, losses, and deductions on Schedule C of your personal federal tax return and net income would be taxed at your individual income tax rate.
 
[[AdMiddle]If you had aspirations to grow your bakery into a big business, sell shares of stock, and maybe even take it public someday, you’d need to set it up as a C corporation. In this case, your business would be a separate taxable entity and income, losses, and deductions would not pass through to your personal tax return. Instead, the corporation would file its own tax return and pay tax on profits at special corporate tax rates. The drawback of a C corporation is the potential for double taxation, which Legal Lad touched on in last week’s episode. In all likelihood, your bakery wouldn’t need to issue stock or go public, so a C corporation would not be a good fit.
 
An S corporation or an LLC would both be reasonable choices. Both provide limited liability, and your share of business income, losses, and deductions will pass through to you. You report net income on your personal federal tax return and it’s taxed at your individual income tax rate. This is the reason S corporations and LLCs are known as “pass-through” entities.
 
An S corporation has more administrative overhead than an LLC, but it has the potential to save you money on self-employment tax.
 
In the case of your bakery, let’s assume that you would save only a very small amount on self-employment tax by forming an S corp. For this reason, you decide the savings isn’t worth the extra paperwork and hassle of an S corp, and therefore go with the simpler LLC.
 
LL: Thanks, Money Girl. Because there are many factors to consider when choosing the best entity type for your business, it’s a smart idea to consult both an attorney and a tax advisor, and if you can consult with them both together, so much the better.
 
Thank you for listening to Legal Lad’s Quick and Dirty Tips for a More Lawful Life. Be sure to check out all the excellent Quick and Dirty Tips podcasts at QuickAndDirtyTips.com.

You can send questions and comments to legal@qdnow.com. Please note that doing so will not create an attorney-client relationship and will be used for the purposes of this podcast only.

 
Legal Lad's theme music is "No Good Layabout" by Kevin MacLeod.
 
 

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