LLC or Corporation?: Choose the Right Form for Your Business

By Anthony Mancuso

LLC vs. C Corp vs. S Corp: One of the most important business decision you’ll make 

Whether you're starting a new business or growing an existing one, the big question is “Which legal structure is best for my business?” The answer has important legal and tax consequences.

LLC or Corporation? explains:

• the basics of all business entities

• how to avoid being personally liable for business debts (by forming an LLC or corporation) 

• how to minimize taxes by choosing the right entity

• how to convert from one business entity to another, and

• requirements for doing business out of state.

LLC or Corporation? is packed with real-world examples to help you make the best choice for your company. 

• Language: English
• Publisher: NOLO
• Release date: Aug 1, 2023
• ISBN: 9781413330212

Anthony Mancuso

Anthony Mancuso is a corporations and limited liability company expert. A graduate of Hastings College of the Law in San Francisco, Tony is an active member of the California State Bar. Tony writes books and software in the fields of corporate and LLC law and has studied advanced business taxation at Golden Gate University in San Francisco. He also has been a consultant for Silicon Valley EDA (Electronic Design Automation) and other technology companies. He is currently employed at Google in Mountain View, California. Tony is the author of many Nolo books on forming and operating corporations (profit and nonprofit) and LLCs. Among his current books are The Corporate Records Handbook; How to Form a Nonprofit Corporation; Incorporate Your Business; Form Your Own Limited Liability Company; and LLC or Corporation? His books and software have shown over 500,000 businesses and organizations how to form and operate a corporation or an LLC. Tony is a licensed helicopter pilot and guitarist.

Book preview

Cover: LLC or Corporation?: Choose the Right Form for Your Business edited by Attorney Anthony Mancuso

Get More on Nolo.com

Go to this book’s companion page at:

www.nolo.com/back-of-book/CHENT.html

Checking the companion page is a good way to stay informed on topics related to this book.

More Resources from Nolo.com

Legal Forms, Books, & Software

Hundreds of do-it-yourself products—all written in plain English, approved, and updated by our in-house legal editors.

Legal Articles

Get informed with thousands of free articles on everyday legal topics. Our articles are accurate, up to date, and reader friendly.

Find a Lawyer

Want to talk to a lawyer? Use Nolo to find a lawyer who can help you with your case.

The Trusted Name

(but don’t take our word for it)

In Nolo you can trust.

THE NEW YORK TIMES

Nolo is always there in a jam as the nation’s premier publisher of do-it-yourself legal books.

NEWSWEEK

Nolo publications … guide people simply through the how, when, where and why of the law.

THE WASHINGTON POST

[Nolo’s]… material is developed by experienced attorneys who have a knack for making complicated material accessible.

LIBRARY JOURNAL

When it comes to self-help legal stuff, nobody does a better job than Nolo …

USA TODAY

The most prominent U.S. publisher of self-help legal aids.

TIME MAGAZINE

Nolo is a pioneer in both consumer and business self-help books and software.

LOS ANGELES TIMES

10th Edition

LLC or

Corporation?

Choose the Right Form

for Your Business

Attorney Anthony Mancuso

Logo: Nolo

TENTH EDITION

AUGUST 2023

Editor

GLEN SECOR

Cover Design

SUSAN PUTNEY

Book Design

SUSAN PUTNEY

Proofreading

MARTHA C. BENCO

Index

VICTORIA BAKER

Printing

SHERIDAN

ISSN: 2473-4470 (print)

ISSN: 2473-4489 (online)

ISBN: 978-1-4133-3020-5 (pbk)

ISBN: 978-1-4133-3021-2 (ebook)

This book covers only United States law, unless it specifically states otherwise. Copyright © 2005, 2006, 2008, 2010, 2012, 2014, 2016, 2018, 2020, and 2023 by Anthony Mancuso. All rights reserved. The NOLO trademark is registered in the U.S. Patent and Trademark Office. Printed in the U.S.A.

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise without prior written permission. Reproduction prohibitions do not apply to the forms contained in this product when reproduced for personal use. For information on bulk purchases or corporate premium sales, please contact [e-mail].

Please note

Accurate, plain-English legal information can help you solve many of your own legal problems. But this text is not a substitute for personalized advice from a knowledgeable lawyer. If you want the help of a trained professional—and we’ll always point out situations in which we think that’s a good idea—consult an attorney licensed to practice in your state.

MH Sub I, LLC dba Nolo, 909 N. Pacific Coast Hwy, 11th Fl, El Segundo, CA 90245.

Acknowledgments

Thanks to Nolo for helping to make this and other consumer law books available to the public over the past 50+ years.

About the Author

Anthony Mancuso is a corporations and limited liability company expert. A graduate of the University of California College of the Law, San Francisco, Tony is an active member of the California State Bar, writes books and software in the fields of corporate and LLC law, and has studied advanced business taxation at Golden Gate University in San Francisco. He also has been a technical writer for technology companies. Tony currently works for Google in Mountain View, California.

He is the author of many Nolo books on forming and operating corporations, profit and nonprofit, and limited liability companies. Among his current books are Incorporate Your Business: A Legal Guide to Forming a Corporation in Your State, The Corporate Records Handbook: Meetings, Minutes & Resolutions, How to Form a Nonprofit Corporation, Form Your Own Limited Liability Company, and Your Limited Liability Company: An Operating Manual. His books and software have shown over a quarter of a million businesses and organizations how to form and operate a corporation or LLC.

Tony has lectured at the University of California, Berkeley, School of Law (Using the Law in Non-Traditional Settings) and at Stanford Law School (How to Form a Nonprofit Corporation). He taught Saturday Morning Law School business formation and operation courses for several years at the Nolo Press offices in Berkeley. He has also scripted and narrated several audiotapes and podcasts covering LLCs and corporate formation and other legal areas for Nolo, as well as The Company Corporation. He has given many recorded and live radio and TV presentations and interviews over the years covering business, securities, and tax law issues. His law and tax articles and interviews have appeared in The Wall Street Journal and on TheStreet.com.

Tony is a licensed helicopter pilot and has performed for years as a guitarist. For links to his books and software, go to the Nolo website (www.nolo.com).

Table of Contents

Your Legal Companion

PART 1

1Business Entity Basics

Why Your Choice of Entity Matters

Sole Proprietorships

General Partnerships

Limited Liability Companies (LLCs)

Corporations

S Corporations

Special Business Entities: Limited Partnerships, Entities for Professional Businesses, Benefit Corporations, and Series LLCs

2Personal Liability Concerns

How Your Choice of Business Entity Affects Personal Liability

Using Insurance to Limit Liability

3Forming and Running Your Business

Forming and Running a Sole Proprietorship

Forming and Running a Partnership

Forming and Running an LLC

Forming and Running a Corporation

Form Your Own LLC or Corporation

4Money Issues: Taxes, Profits, Losses, and Investments

Taxes

Paying Out Profits

Start-Up Losses

Private Investors: Angels and Venture Capitalists (VCs)

LLC or Corporation Comparison Table

5LLC or Corporation: Four Business Stories

Gabby’s Gears: Sole Proprietorship, Single-Member LLC, or Single-Owner Corporation?

Fast Food Fusion: A Two-Owner Start-Up Business Chooses a Business Form

Soaring Duck Machines Seeks a Different Tax and Ownership Structure

SerMin Technologies: Forming a Tech Startup

PART 2

6Converting a Sole Proprietorship to Another Entity

Converting a Sole Proprietorship to a Partnership

Converting a Sole Proprietorship to an LLC

Converting a Sole Proprietorship to a Corporation

7Converting a Partnership to Another Entity

Converting a Partnership to a Sole Proprietorship

Converting a Partnership to an LLC

Converting a Partnership to a Corporation

8Converting an LLC to Another Entity

Converting an LLC to a Corporation

Converting a Multi-Member LLC to a Single-Member LLC

Converting a Single-Member LLC to a Multi-Member LLC

9Converting, Dissolving, and Selling a Corporation

Converting a C Corporation to an S Corporation

Liquidating and Dissolving a Corporation

Selling a Corporation

PART 3

10Doing Business Out of State

Doing Business Out of State

Qualifying to Do Business

Paying and Collecting Taxes in Other States

Internet Issues

Appendix

State Website Information

State Business Entity Filing Websites

State Tax Office Websites

State Securities Office Websites

Index

Your Legal Companion

One of the most important choices you make when starting a business (whether by yourself or with others) is whether a limited liability company (LLC) or corporation will best meet your needs. Or perhaps you’ve already organized your business but want to explore the possibility of converting to a business entity with more favorable legal and tax characteristics.

In both cases, this book will help you with your decision. Although the focus of this book is on choosing whether to form an LLC or corporation, it’s helpful to know about the other two leading business forms (sole proprietorships and partnerships) and how they compare to LLCs and corporations. This book explains the legal and tax characteristics of each of these business entities and the basic rules for converting one type of business to another.

This book also provides information about S corporations as a tax choice for corporations (and LLCs to a much lesser extent), along with special entity choices for professional businesses. I’ve divided this book into three parts.

Part One discusses basic information about each type of business entity. It includes the following chapters:

Chapter 1 discusses each type of business entity, including the relative advantages and disadvantages of each.

Chapter 2 explains how your choice of entities affects your personal liability for debts against your business.

Chapter 3 examines the relative ease with which each of the entities can be formed and managed.

Chapter 4 covers how each entity deals with profits, losses, investments, and taxes.

Chapter 5 provides case studies of LLC or corporation choices for four different businesses.

Part Two includes the following chapters:

Chapter 6 discusses converting a sole proprietorship to another entity.

Chapter 7 discusses converting a partnership to another entity.

Chapter 8 discusses converting a limited liability company to another entity.

Chapter 9 discusses converting a corporation to another entity, and reorganizing or dissolving a corporation.

Part Three discusses doing business out of state:

Chapter 10 is a bonus chapter on qualifying to do business and paying taxes in other states.

This book includes links you can use to find information regarding your state’s corporate and LLC rules, as well as tax and securities laws information (see the appendix).

Business law and tax rules can get a bit complicated. Don’t worry. They’re presented here in plain language, with as little legal and tax jargon as possible, and with red flags for when you should consider getting help from legal and tax professionals.

By the time you finish this book, you’ll understand what each type of entity has to offer, and you’ll be ready to choose the right structure for your company. By the way, Nolo (www.nolo.com), the publisher of this book, provides many ways to assist you when it comes to corporations and LLCs, including assistance with state filings, helpful books, and lots of free information. Go to www.nolo.com and visit the Business Formation area.

PART

1

CHAPTER

1

Business Entity Basics

Why Your Choice of Entity Matters

Sole Proprietorships

Number of Owners

Liability for Business Debts: No Limited Liability

Income Tax Treatment

General Partnerships

Number of Partners

Liability for Business Debts: No Limited Liability

General Partnership Income Taxation

Limited Liability Companies (LLCs)

Number of Owners

Liability for Business Debts: Owners Have Limited Liability

Pass-Through Taxation

Management

Formation Requirements

Corporations

Number of Shareholders (Owners) and Directors

Liability for Business Debt: Owners Have Limited Liability

C Corporation Income Taxation

Corporate Management

Corporate Capital and Stock Structure

Employee Fringe Benefits

S Corporations

Number of Shareholders (Owners) and Directors

Liability for Business Debts: Owners Have Limited Liability

S Corporation Income Taxation

S Corporations Compared to LLCs

Disadvantages of the S Corporation Compared to the C Corporation

Special Business Entities: Limited Partnerships, Entities for Professional Businesses, Benefit Corporations, and Series LLCs

Limited Partnerships

Professional Business Entities: Limited Liability Partnerships (LLPs), Professional Limited Liability Companies (PLLCs), and Professional Corporations (PCs)

Benefit Corporations

Series LLCs

Do you really have time to read this book? Shouldn’t you be devoting more time to your accounting, your competition, your overhead, or your business plan? After all, as Calvin Coolidge once said, The chief business of the American people is business—so why not hire a lawyer to advise you about your choosing a legal entity for your business, put down this book, and get back to work?

Why Your Choice of Entity Matters

Here are three reasons why you need to learn more about the various legal forms your business might take:

You’re making a business decision. Your choice of business entity affects how ownership is structured, how the company is managed, how the business is taxed, how you take money out of the business, and how you can raise capital. In other words, your decision about what type of business entity to form can be as crucial to your business success as your marketing, hiring, or sales decisions. If you want limited liability protection, which we discuss in this chapter and explore further in Chapter 2, your choice will be between an LLC or a corporation. This book will help you understand the legal and financial basics of each business structure.

You can save money. Hiring a lawyer can be helpful, particularly if there are disputes among multiple owners of a business. But hiring a lawyer can also be expensive or unnecessary. If you take the time to read this book, you can save money and make a reasoned decision about your choice of entity. You can also save money by using products or services that specialize in business formation. If you do hire a lawyer, the knowledge you gain from this book will help you to work more efficiently together.

You’ll keep your options open. As businesses grow, they often change their form of entity. A business might start as a sole proprietorship or partnership and then evolve into a corporation or LLC. The business entity you choose today might affect your choice of entity in the future. In other words, you’re not just picking a business entity; you’re plotting a business strategy. The more information you have, the better equipped you’ll be to plot the right course.

Now that you know why this is an important decision, it’s time to learn some basic information about each type of business entity.

Sole Proprietorships

The simplest way to be in business for yourself is as a sole proprietor. This is just a fancy way of saying that you are the owner of a one-person business. Forming a sole proprietorship involves almost no cost or bureaucratic red tape, other than the usual license, permit, and other regulatory requirements that your state, locality, or both imposes on any business. And you don’t have to do anything to create a sole proprietorship: If you start a one-person business and don’t form a corporation or LLC, you have created a sole proprietorship, and that’s how the state and the IRS will treat your business.

As a practical matter, most one-person businesses start out as sole proprietorships just to keep things simple.

EXAMPLE: Winston is a graphic artist who started a sideline computer graphics business in his garage. Winston works only part time in his own business and has no employees. He has just a couple of clients and no pressing personal liability issues, so he chooses to operate as a sole proprietor (his other choices would be to form an LLC or a corporation). Outside of a business license, fictitious name filing, and tax permit, Winston does not need to file any legal paperwork. Unless Winston takes steps to change the legal structure of his business—by filing the necessary papers with his state to form a one-person LLC or corporation—his business will automatically be classified and treated as a sole proprietorship.

Number of Owners

By definition, a sole proprietorship has only one owner. If your one-person business grows and you wish to include other owners, you’ll need to choose another business structure, such as a partnership, LLC, or corporation.

Liability for Business Debts: No Limited Liability

Unfortunately, although forming and running a sole proprietorship is simple, it can also be risky. That’s because sole proprietors are 100% personally liable for all business debts and legal claims. To put it another way, sole proprietors do not have limited liability protection against creditors of the business, the way an owner of an LLC or corporation does.

For example, if someone slips and falls in a sole proprietor’s office or store and then sues, the owner is responsible for paying any resulting court award (unless commercial liability insurance covers it). Similarly, if the business fails to pay suppliers, banks, or bills from other businesses, the owner is personally liable for the unpaid debts. This means that the owner’s personal assets, such as bank accounts, equity in a house or car, and other personal assets, can be taken by court order and sold to repay business debts and judgments.

Of course, some businesses are much more vulnerable to debts and lawsuits than others. If you run a business that doesn’t operate on credit and is unlikely to be sued, limited liability might not be essential for you. (Chapter 2 provides more information about personal liability.)

Income Tax Treatment

In the eyes of the IRS, a sole proprietorship is a disregarded entity. The IRS does not have a tax return for the sole proprietorship. Instead, sole proprietors report their business profits or losses on IRS Schedule C, Profit or Loss From Business (Sole Proprietorship), which they file with their 1040 individual federal tax returns. The owner’s profits are taxed at their individual income tax rate. This is called pass-through taxation because the income passes through the business to the owner’s individual tax return. Partnerships, LLCs, and S corporations, each of which we discuss below, are also pass-through entities. C corporations aren’t.

Schedule C is simpler than corporate and partnership tax returns. If you prepare your own individual tax returns, you might find it easy to add Schedule C for your business. Or, if you pay a tax preparer, the cost for Schedule C should be less than what you would pay for a partnership or corporate return.

Because sole proprietors are self-employed, they have no employer to chip in part of their Social Security and Medicare taxes (called self-employment taxes for those working for themselves and FICA taxes for regular employees). Regular employees generally pay half of these taxes through payroll deductions, and the employer pays the other half. Sole proprietors must pay the entire amount themselves (by preparing Schedule SE, the Self-Employment Tax return, which must be filed along with a Schedule C and 1040 income tax return each year).

Although having to pay all of the Social Security and Medicare taxes might seem like a disadvantage of forming a sole proprietorship, it actually isn’t. If that same sole proprietor had instead formed a one-person corporation, he or she would personally pay half of the tax and the corporation would pay the other half. The money would come from two different sources, and the tax reporting requirements are different, but the whole amount still ultimately comes out of the owner’s pocket.

TIP

Unincorporated business owners can deduct the cost of health insurance. Federal tax law allows sole proprietors, partners, and LLC owners who work as employees in their business to deduct the full cost of health insurance premiums paid out by their business for themselves and the other employees in the business. This tax break is available to unincorporated business owners who work in their business. (For sole proprietors, the deduction is available only if neither the sole proprietor nor their spouse is eligible to participate in an employer-sponsored health plan.)

General Partnerships

A partnership is a business in which two or more owners agree