CORPORATIONS AND LLCS

If one or more people wish to own real estate together, for business reasons, they should consider taking title through a corporation or a limited liability company (LLC).  Like a partnership, a corporation or an LLC is a legal entity which is distinct from its owners.  Under the law, a corporation or an LLC is a “person,” which has its own name, its own federal employers identification number and which can own property.

The primary advantage of a corporation or LLC, as opposed to a partnership, is protection against creditor claims.  In a general partnership, each partner is individually liable for the debts of the business.  In a corporation or an LLC, however, the owners of the business ordinarily are not liable for business debts.  There are exceptions to this rule, but there is no question but that the corporate form provides a significant level of protection to its owners.

Forming a corporation or LLC is relatively simple.  To do so, written Articles of Incorporation must be filed with the California Secretary of State.  After the entity is formed, various formalities must be followed each year to maintain the corporate status.

There are three primary distinctions between corporations and LLCs.  First, LLCs require significantly less paperwork to maintain than do corporations.  Thus, other things being equal, an LLC is usually a better choice, particularly for a small business.

Second, the two entities can be taxed differently.  As a rule, the income of a corporation is taxed.  Thus, there is a double taxation problem with corporations.  Business income can be taxed, once, as corporate income, and then a second time, as individual income, after it is distributed to its owners.   This problem applies only to “C” corporations.  “S” corporations do not have their income taxed.  Instead, their tax attributes flow directly through to their owners, who pay income tax only once on income.  Please note, however, that there are complex rules relating to the taxation of S and C corporations; if you use either corporate form, you should consult with a tax specialist on the application of these rules to your situation.

An LLC avoids this double taxation problem.  Although it provides the same level of protection against creditors as does a corporation, it is taxed like a “S” corporation and thus avoids the double taxation problem.  (Please note, however, that an LLC can elect to be taxed like a “C” corporation.  Please consult a tax specialist if this issue is of concern to your business.)

The third distinction between a corporation and an LLC relates to the number of owners.  An LLC is designed to have a small number of owners.  If your business has more than a half dozen owners, the LLC form is less useful for you.  Please note, however, that if your business has more than a half dozen owners, you face a wide range of issues upon which you will need legal counsel.  For example, if you have a large number of owners, it is very possible that you will have to comply with Federal and State securities laws.

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