A question I’m often asked is: “How should I structure my business?”
LLC? S corp? C corp?
The answer depends on the company and the wants, needs, and plans of its owner or owners. One structure is not better than any other until we see the big picture.
Several years ago, the limited liability company would not have been part of the discussion because many people were afraid to structure as an LLC. That is no longer true. Case law has clearly established that the LLC will be respected, so we don’t have to worry about that. What we need to worry about is what is the best structure for a given company in a given situation. Let’s run through each entity form, covering some of the pros and cons of each.
LLCs are very flexible. They are a combination of corporations and partnerships — two different legal systems combined into a new paradigm. What it blends is the freedom of contract. You can set up an LLC agreement any way you want with the limited liability that business owners so frequently desire. In many cases, it’s the best of all worlds.
The pros of the LLC include: Flexibility, the potentially limited liability if done correctly, the ability to blend things the way you want, and the ability to make the company reflect your management style.
The cons of the LLC include: The statute doesn’t have a lot of defaults so if you have a problem, you need to fall back to your LLC agreement. If the agreement isn’t robust, you will end up in a system set up by someone else. Also, because LLC agreements are so easy to set up, people make mistakes. Many people misinterpret the ease as meaning little has to be done, and they miss important steps in the process. On top of that, some investors and funds simply prefer corporations over LLCs.
Corporations are the old standby. C corps been around for quite some time and are well-known. They have a set structure for management that locks in the way things are done.
The pros of C corps include: The set structure makes it simpler to set up, in some ways. There’s typically more paperwork required to set up corporation than an LLC, but you don’t have to spend time and energy documenting how the structure works. Corporations are well-respected; people’s understanding of corporations helps you get business done. In international transactions, sometimes a corporation is more recognized than an LLC because corporations have been around longer.
The cons of C corps include: The structure that works so well for some people is also rigid and doesn’t give business owners a lot of flexibility. The corporation is much more difficult to set up with investors, veto rights and other items like that, so to make it do very particular things in a very particular way is harder than with an LLC.
S corporations are sisters to C corps. You take a C corp or even an LLC, and you elect to be taxed as an S corp. The Internal Revenue Service dictates certain requirements for an S corp, such as limiting the number of stockholders and requiring them to be U.S. citizens. You have to make sure you qualify for S chapter treatment. This eliminates the two levels of taxation. Typically, a C corp is taxed at a corporation level, and then dividends are sent out, and they are taxed at the shareholder level. The S corp eliminates that because the only tax layer is at the shareholders’ level. For that reason, you can see that as a positive in many cases.
Also, for tax purposes, an S corp recognizes the difference between ownership and participation in the business, whereas an LLC is typically a flow-through entity. The tax rules blend the payment for the ownership services and their profits for being a business owner. With an S-corp, you can do a better job at splitting these two revenue streams. We have a real benefit here in many cases.
The cons of an S corp include: The IRS may challenge the structure, so you need to document that you’re paying fair compensation. In many cases when people set up an LLC with flow-through taxation, it would make more sense to use an S corp.
What other issues do you see? What other questions do you have about these structures? Let us know so we can structure future content. Are you struggling with this choice and why? What are your particular issues? Join us in the comments below and let us know your thoughts and experience.
Each case is unique. Past results do not guarantee future outcomes. This posting is intended to be a tool to familiarize readers with some of the issues discussed herein. This is not meant to be a comprehensive discussion and additional details should be discussed with your attorneys, accountants, consultants, bankers and other business planners who can provide advice for your circumstances. Each case is unique. Past results do not guarantee future outcomes. This article should not be treated as legal advice to any person or entity. FreeImages Photographer Odan Jaeger.
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