LLC v. Corp: Pros & Cons
When you are starting a business, choosing the right type of entity is one of the most important decisions to make. Different types of entities provide different tax benefits and burdens, are subject to different regulatory requirements, and offer different levels of protection from personal liability for principals of the company. Below we discuss the pros and cons of forming a limited liability company (LLC) and forming a corporation. Call a Houston business law attorney with additional questions or for help with a Texas business law matter.
Corporations are legal entities that are separate from the owners. Corporations are subject to strict regulations concerning their corporate structure, reporting to the IRS and state agencies, and management. Corporations must have a board of directors, must have bylaws, must hold annual shareholder and director meetings, and the company and its directors owe responsibilities to participating shareholders. Corporate shares are easy to transfer from one party to another, so a company that plans to have outside investors or eventually become publicly-owned benefits from being a corporation.
Corporations can be taxed in one of two ways, depending on the number of members. All corporations are, by default, taxed as C corporations. C corporations pay federal income tax on corporate profits, and shareholders pay another tax on dividends that they receive. Some people refer to this as “double-taxation,” when a corporation pays tax on its own income and then shareholders pay another tax on the corporation’s profit at the end of the year that is distributed to the shareholders. Corporations are able to claim a variety of tax deductions and obtain fringe benefits without taxation, however.
Corporations that have 100 or fewer shareholders can choose instead to be taxed as an S corporation. An S corporation pays no taxes at the corporate level. Instead, individual shareholders pay tax on distributions they receive. They are taxed at a higher rate, however, so individuals who make a high income from distributions will likely pay higher taxes. If shareholder income is modest, then S corporation tax designation is preferable to C corporation.
Limited Liability Company
LLC stands for “limited liability company.” An LLC is an entity distinct from the owners, who each own a designated percentage of the company (sometimes called a membership interest). Owners, also called members, are protected against individual liability for the actions of the company.
LLCs are designed to have a more flexible management structure than corporations. They can be managed by members or by a group of managers, depending on how hands-on the owners prefer to be (they could be hands-off investors, for example). Ownership interests are more difficult to transfer than are shares in a corporation, and different state laws set strict requirements for how ownership can be transferred. LLCs have fewer formal reporting and recordkeeping requirements than corporations.
LLCs can choose how to be taxed. By default, a single-member LLC is taxed like a sole proprietorship while a multi-member LLC is taxed like a partnership. LLC members would thus report and pay tax on business income as part of their personal tax returns. LLC members can also be liable for self-employment taxes, unlike corporate shareholders. But an LLC can also elect to be taxed as an S corporation or a C corporation, so long as it qualifies.
LLCs benefit from an easier structure to manage and fewer regulatory requirements than corporations, a bonus for smaller businesses. They may be limited, however, by the hurdles that go into transferring ownership, limiting the ability to bring in outside investors, and the business may only be able to grow so much. Speak with your accountant and business law attorney to discuss your business and the ideal corporate structure based on your business model and your preferences.
For help forming your startup business or with other business law issues in Texas, contact the professional, efficient, and effective business lawyer Leigh Meineke at the Houston offices of Stephens | Domnitz | Meineke PLLC at 832-706-0244.