Basic Terminology to Know when Setting up a Company
I notice that many people mix up different corporate and tax terminology and are often confused by it. As I have encountered that a few times recently, I thought the newsletter was a good place to try to dispel some of the confusion.
Starting with the LLC, as that has become the most common these days. A limited liability company often has one owner or “Member”, but it can have many members. It is relatively easy for an individual to set this up with their state corporation commission. Members are the owners of the LLC and Managers are the people, as you might expect, who manage the LLC. The Members and Managers can be the same person(s), or they can be completely different individuals or entities. Often an LLC with a single Member, files as “Member Managed”, and then it is the same person owning and managing the LLC. LLCs can have and should have Operating Agreements. If you do not have one, you may have issues with bank accounts or lenders; but more importantly, state statutes will determine the rules the LLC is operating under. Meaning the state chooses, since you were silent.
A connected but different concept is the tax election that the Members decide for their LLC. Often an LLC files with the IRS to be a “S Corp”. This means that the LLC is a disregarded entity for tax purposes and the income or losses flow through each year to the Members. The Members report the income or loss on their personal tax returns. “S Corp” is not a corporate formation, it is a tax election.
Then there are incorporated companies or “Inc.’s. This is usually reserved to a company with larger revenues or with more than one owner, but not necessarily. In an Inc., the owners are called shareholders and the agreement that governs the Inc’s operations is called By Laws. There may also be a Shareholder Agreement and different classes of shares may be issued providing different voting rights or economic rights. This kind of company has a Board of Directors v. an LLC, which has Managers. The Board of Directors and the Shareholders are also not necessarily the same persons or entities. Usually the larger Shareholders have the right to appoint a director or two on the board.
An incorporated company can make the tax election to be a “S Corp” or it can elect to be a “C Corp”, which means the income and losses are held at the company level. People summarize this often as saying there is double taxation for a company that has elected to be a C Corp. There are benefits and drawbacks of either tax election, which is a discussion for a different day.
In summary, generally speaking if you have an:
LLC, you have Members and Managers, you should have an Operating Agreement and are most likely filing your taxes as a “S Corp” v.
Inc. or Incorporated entity, you have shareholders, a Board of Directors, By-Laws and can elect to be an “S Corp” or a “C Corp” with the taxing authorities.
Disclaimer – This article is for information purposes only. It is not intended to provide legal advice to anyone. If you require advice, you should reach out to our firm or another lawfirm to discuss your facts and circumstances to obtain legal advice.
