Reasons to Incorporate or Form an LLC

LLC Corp Book I’ve been reading LLC or Corporation?: How to Choose the Right Form For Your Business by Nolo Press, which writes a lot of do-it-yourself legal books aimed for the public. Some of the little details just make my head spin, but here are the main benefits of forming a corporation or limited liability company (LLC) for an individual:

1) More job opportunities. Many companies won’t hire an independent contractor unless they are an LLC or corporation. This is because they are afraid of the IRS classifying you as an employee later, and then charging them possibly years of back employment taxes.

2) Limited liability for business debts. As a sole proprietor, if your business goes under you are personally responsible for all the debts. That means your house, your car, and everything else you own can be taken away to pay off those debts. This doesn’t protect you from everything all the time, though.

3) Save on taxes. With corporations and LLCs, there are strategies to minimize your income tax liability. Depending on your business type and expenses, you could save a significant amount of money. However, you must balance these with the additional paperwork and formation fees involved.

If you are trying to build a business that you could potentially grow and sell, then there are other things to consider. This is just a general overview of the benefits I’m seeking, I’ll go more into the similarities and differences of limited liability and tax-minimization for LLCs and Corporations (both S-Corps and C-Corps) to help me decide which one to form.


  1. As an aside, I have an single member LLC that I put my rental property in. The taxation is pass through, so I guess they could be considered dividends…My question is, what is the best type of retirment plan that I could put the money in?

  2. I am not sure exactly how rental income is treated tax-wise, but I don’t believe it is treated as self-employment income. I’m sure someone else can chime in with more details.

    For things that are considered SE income, I wrote about SEP-IRAs a little bit already, and I’m going to write about Solo 401(k)s and Solo Roth 401(k)s later after I get this incorporation thing out of the way. I’d look into those two mainly, although there are also other alternatives.

  3. Marvin Ogg says:

    BC, the rental income passes through for tax purposes as if your LLC didn’t exist. It is considered income, not dividends.

    The best type of retirement plan is generally self employed 401k. Fidelity has a good one here:


    However, the income you receive from your rental is passive income and cannot be used for retirement plans.

  4. For small business, you best bet is between S-corp or LLC. Personally, I would go for S-corp if I could. Of course you will need to get more paperwork done (shares, articles of corporation, minutes, etc.) but it’s also more fun. Moreover, if you got one or two partners and you want to put together some capitals (even only a few thousand dollars), S-corp will serve you in the long run. LLC generally don’t grow very fast or they never grow. If that’s your aspiration.

  5. My Personal Finance Blogger says:

    I wouldn’t think you need to form an LLC or Corp (S or C) for what you’re doing. The main benefit is in managing liability which is probably a small risk in the business you’re in. You will not be likely to get unsecured credit for the business for quite some time in any case. There are costs (financial and time) in doing either.

    As for companies not wanting to hire you unless you’re an LLC/Corp, I’ve never heard or experienced that and I’ve been in business off and on for over ten years. I would imaging they would be fine with you setting yourself up with a dba and tax ID #… I could be wrong though, I’m only going on my experience here in Michigan and earlier in New York.

  6. I have an S-Corp for my consulting work (which is my ‘full time’ job) and a LLC for an apartment building I own. Here’s why:

    With the S-Corp you can save a bit on payroll taxes (namely social security and medicare). Basically you pay yourself a ‘reasonable’ salary on which you pay payroll taxes. The rest of the profit of the S-Corp still flows to me, but I pay only federal and state, not SS and MED. I do have to pay some unemployment taxes, but the amount is nominal (less that $300/year). This isn’t possible with an LLC. There I would be treated as a partner (unless I elect to be treated as a corporation for tax purposes but then you run into double taxation issues) and would pay self employment tax on everything.

    I also find that my clients, usually Fortune 500 corporations and large consulting firms, only want to do corp-to-corp. They don’t want to worry about 1099’s and they insist on E&O and liability insurance. It’s part of the ‘approved vendor’ process.

    For the apartments, the biggest concern is liability and asset protection. From a tax standpoint, I lose money because of the depreciation so taxes aren’t an issue. However, any bank will make you personally guarantee the mortgage debt anyway but I’m more concerned about getting sued by a tenant… you just have to be careful about how you do it so someone can’t get past LLC and get your personal assets. I don’t know the details, but have an attorney who does.

    By the way, a single member LLC is ‘disregarded’ for tax purposes. In the IRS’s eye, you are a sole proprietor. So unless you are doing it for liability issues, don’t bother for tax.

  7. One more thing… I did a Fidelity Self Employed 401(k) for 2005. Not too be too much of a nerd, but I was giddy at the proposition. Much better than a SEP for me because of the S-corp. My consulting friends couldn’t believe it and my accountant didn’t understand it at first!

    Remember, I pay myself a salary from my S-corp. Only the salary could be considered for the SEP, but I want to minimize the salary because of payroll tax. So my SEP limit was very low because of the low salary; the ‘dividend’ portion of my S-corp income is not included in the SEP limit calculation.

    So let’s say my salary was $40k. My SEP limit would have been $10k. With the 401k for 2005, I could save up to $24k (2.4 times the SEP limit). $14k in salary deferral plus a profit share up to 25% of compensation (salary).

    It worked very well in my S-corp situation… but with a LLC everything is flowing through anyway so it would seem a SEP would be fine, you have a higher limit.

    Fidelity’s people were very well informed; no ‘you’ll have to consult your tax advisor about that’. I was blown away at their level of knowledge.

  8. You guys are right, I shouldn’t have put LLC for an *individual* in my post. It is actually for my wife and I together. Then there is some possible tax benefit with income shifting.

  9. Income shifting? Your household might be making more than you let on – doesn’t that really only do you good if one of you hits the SSN cap??

  10. The key word here is ‘possible’ 🙂 We want to form one together as we want to start another business together. An LLC would serve as a possible umbrella for all our businesses.

    And you’re right, it would only matter if we reach the SS cap. All these scenarios involve future increases of income. S-Corps also give you very little tax benefit if you’re only making 20k a year.

  11. Can’t go wrong with an S-Corp or an LLC. If you plan to get sort of big, do the S. If you plan on raising a lot of money, do a C-Corp. I doubt you’d need money, and the S-Corp can be fairly easily converted to a C-Corp if you ever needed to do so.

  12. Let me add a point of clarification. You can chose to form an LLC and elect to be treated as a Corp and elect to be treated as an S-Corp. Don’t look at an LLC and S-Corp as mutually exclusive.

    There are default classifications when an LLC is formed and when no election is made (Single Member = disregarded, More than one member = Partnership).

  13. Donald J. Kindwald says:

    I am a lawyer who represents many small to medium sized businesses. When I first meet a new client the first item of business that I attend to is to make sure that they have followed all of the requisite corporate formalities and that their business is “bullet-proof”. The protection of a corporation or a limited liability company is priceless when the business is the target of a creditor or a lawsuit. The most common mistake that businesses make is not to confirm that they have the corporation protection that they require. It is only when it is “too late” that the business finds out that simply sending the $100 annual fee to the secretary of state is not enough.

  14. Incorporation Guru says:

    Advantage of LLC is avoiding double taxation and having the profit or loss pass through to the member. The Limited Liability Company is not taxed itself as it is passed through to the members and only taxed once like the earnings from an S Corporation, Partnership or sole proprietorship.

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