January 20, 2011

LLC Vs Corporation: Making the Best Choice

Small businesses hoping to protect themselves and their owners regularly ask which option is better: a limited liability company or a corporation. And no wonder.

You can hear knowledgeable attorneys and accountants argue passionately for either option.

Nevertheless you can often get a good answer about what makes most sense in your specific situation by looking at the best reasons to form an LLC and the best reasons for incorporating.

Reasons to Choose LLC Option

Two big reasons suggest choosing the limited liability company option. The first reason? A limited liability company requires simpler governance as well as less red tape and paperwork.

By design, LLCs are set up so people can easily govern how the LLC's owners interact with the LLC and how the LLC governs itself. This "ease" means that correctly operating an LLC (in a legal sense) is very easy. A one owner LLC (also known as a single-member LLC) can safely and legally operate using the simplest of procedures and guidelines. (In contrast, corporations typically need to schedule annual shareholder meetings and regular board of directors meetings--and then corporations also need to appoint corporate officers to run things on a day to day basis.)

The second reason one chooses an LLC concerns the tax rules for LLCs. An LLC provides a really unique tax advantage as compared to a regular corporation. A one-owner limited liability company can be "disregarded" as a separate taxpayer and then just show its income and deductions on its owner's tax return. This keeps the accounting really simple.

Note: At some future point, an LLC (including a one owner LLC) can elect to be treated as an S corporation or a C corporation. Note that multiple owner LLCs are treated by default as partnerships but that these LLCs, too, can elect to be treated as S corporations or C corporations.

Reasons to Choose Corporation Option

You can point to at least three good reasons to choose a corporation over an LLC, even if you're initially going to be a rather small-time operation.

First of all, a corporation gets some "branding" benefit just by being a a traditional "corporation." This is weird, I'll admit. But sometimes customers and vendors just plain think that a corporation is (or sounds) more credible and trustworthy. Accordingly, if for basically psychological reasons you want a corporation or you want words and acronyms like "inc," "corp," "incorporated," or "corporation" in the business name, by all means, chose a corporation. Period.

A second benefit of a traditional corporation concerns the extra governance controls required by a traditional corporation. And, in essence, this is the flip side to that coin about LLCs requiring less governance. People (like outside shareholders) may require the governance controls that a traditional corporation provides. And in this case, one obviously wants to use a regular corporation.

A third benefit of a traditional corporation deserves mention, too. While the extra tax accounting flexibility that an LLC offers its owners sounds appealing, in some situations the entity wants to be taxed as just a regular corporation (also known as a C corporation) right from the get go. In this scenario, one obviously doesn't get any benefit from the extra "tax flexibility" of a limited liability company. Accordingly, selecting a traditional corporation right from the start makes most sense and saves you paperwork. (The traditional corporation will initially automatically be treated as a C corporation.)

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