One of the first things you must do in setting up a business today is to decide where you stand in the LLC vs corporation debate. It’s not at the level of a war, but you’ll sure get different opinions, depending upon which attorney you talk to. Watch the video below for an explanation of the different possible structures.
Tax Structure: LLC vs S Corp vs C Corp
The only difference between an S and C corporation is in their taxation structure. Most small businesses will consider using an S corporation over a C corporation, because an S corporation structure counts as a pass through structure, just like a partnership, while the C corporation does not. The C corporation pays its own taxes directly to the IRS, and the owners also pay tax on the money they get from the company. This can result in a double taxation which hurts the small company owner
The LLC vs corporation question doesn’t hinge on tax structure. 20 years after the LLC structure was created, the IRS finally officially decided that they did not care how an LLC would be taxed. The decision is left to the owner, and has nothing to do with the legal structure. An LLC can choose to be taxed as a sole proprietorship, a partnership, an S corporation, or a C corporation. Most of the benefits available only to a C corporation, such as health and other benefit plans, are also available to an LLC who files their taxes as a C corporation.
Charging Order Protection
When it comes to liability shielding, the S corporation vs LLC shielding is basically identical. However, the LLC does give you “charging order protection” that the corporation can’t give you. In that case, the LLC or S corp decision comes down in favor of the S corp.
The same is true in the LLC vs C corp discussion. The C corp can’t give you charging order protection. Period. That is something the LLC got from its partnership mother, just as it got the corporate shield from its corporation father when it was created in the 1970’s. This charging order has held up very well for all multiple member LLCs in the decades since that time, though you should note that in some states single-member LLCs going through bankruptcy or accused of fraud have had the charging order protection ripped away.
Less Formalities
In the way of “ease of operation,” the LLC verses S corp discussion leans a little in favor of the LLC. The LLC generally has fewer formal operation requirements. For example, the annual meeting you have to have in the corporations isn’t as critical for LLCs.
C corporations have even more onerous requirements, but those same stringent standards are what allow them to list their company on the New York Stock Exchange and accept venture capital, which you cannot do with either an S corporation or an LLC.
Regardless of the level of requirements, you need to establish that any of these entity forms do not comprise your alter ego. Treat the company formally, no matter which entity you choose. Do note, though, that because there are fewer reporting requirements for an LLC, it is more forgiving if you don’t follow the formalities as strictly.
The Professional LLC vs Inc.
Professionals sometimes are confused by their specific limitations in the LLC vs corporation debate, because a professional can’t hide behind the “corporate shield” to protect against malpractice. Professionals include all of the medical, legal, accounting, architecture, engineering, and lots of other fields of work. Professionals setting up a business in order to practice their craft must set up a Professional Limited Liability Company” (PLLC) or a Professional Corporation (PC).
Both share the following characteristics:
- Owners are generally required to be licensed in the same profession
- Proof of licensing is often required for state approval
- Industry-specific regulations may apply to your company name
- States usually require PC or PLLC to be part of your name
Forming these companies may require additional steps on the part of the owners, depending on the regulatory body for their profession in their state. But this is the case for any professional company started, whether PLLC or LLC. Professionals have to have a professional company.
So the designation of a professional company alone does not weigh in to whether a LLC or corporation structure would be better. Either will protect them from all the liabilities of operating their business, except their own malpractice.
Limited Liability Partnerships
Sidenote here: there is one other entity that is often confused with an LLC. It is the LLP or limited liability partnership. It is a relatively new animal. Your professional probably hasn’t addressed the LLP vs LLC issues.
LLPs are primarily used in the areas were large partnerships were used in the last century, i.e., lawyers, and accountants. They limited the liability of the individual partners. (In a true partnership each partner is personally liable.) The liability protection is dependent on state law.<
Most states have adopted some sort of LLP since the 1996 Partnership Act was passed, but their use is still spotty. When it comes to the LLP vs LLC question, you should probably opt for the LLC.
Conclusion
The LLC is a great way to run a business. If you are vascillating between the LLC vs Inc. choices, the LLC would be the default choice for most small businesses. If most of the income from your business is “earned income,” establish an S corporation taxing structure. If most of it is passive income (rents, royalties, etc.) then have your LLC taxed as a Partnership.
It is very rare that a small business would want a C corporation tax structure. You’d better think three times before establishing a C corp structure or electing to have your LLC taxed as a C corp. When it comes to choosing between a LLC vs a corporation, I think the choice is clear. Choose the LLC, because the LLC limited liability shield is basically the same, and the LLC offers the charging order protection that the corporation can’t offer.
Bonus: In order to make sure people know which entity they are doing business with, lawyers came up with different terminology to use in a Corporation vs. an LLC. See a list of these terms and a video of my explanation of them at http://www.llcwizard.com/corporations-vs-llc-terms.
