Limited Liability Company Versus Corporation: Which is Better for a Small Business?
I’ve got a very Washington-state specific discussion of the LLC vs corporation choice here, but I want to provide a bit of more detailed and more general information about this choice.
Small business owners looking for liability protection sometimes wonder which is the better option, a limited liability company or a regular (traditional) corporation.
Unfortunately, you can’t always get a good answer to the LLC vs corporation question. You hear knowledgeable people argue passionately for both options. But let me here give you my opinion of the best reasons to choose a limited liability company and then the best reasons to choose a regular corporation.
Reasons to Choose LLC Option
I think there are probably two big reasons to choose the limited liability company option. The first reason concerns the entity governance (and by this I just mean the red tape and paperwork stuff you’ll need to do in order to keep your LLC’s legal protection in full force). And the second reason concerns the options for true tax simplicity that an LLC offers. Let me quickly discuss both reasons in more detail.
As for the first reason–the point that an LLC requires less governance, red tape and paperwork–let me just say that by design LLCs are structured so you can easily govern how the LLC’s owners transact 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 can safely legally operate by just having the single member do what he or she wants. (In comparison, a corporation probably needs to have annual shareholder meetings, a board of directors that meets regularly, and corporate officers who run things on a day to day basis.)
The second reason one chooses an LLC concerns the tax rules for LLCs. An LLC provides two really unique tax advantages as compared to a regular corporation. For one thing, an LLC with one member, or owner, can be “disregarded” as a separate entity and then just report its income and deductions on its owner’s tax return if it so chooses. This keeps the accounting really simple.
Note: As one example of how this “dis-regardization” of a single member LLC works, take the case of a single member LLC that is owned by an individual and which operates a business. This LLC can treat itself as a sole proprietorship for income tax purposes, which means the LLC’s income and deductions get reported on a Schedule C tax form inside the individual’s 1040 tax return.
Furthermore, an LLC offers a certain amount of tax flexibility because it can often make elections that change the tax accounting rules it uses. For example, a single member LLC might initially be taxed as a sole proprietorship. But at a future point, the LLC could elect to be treated as an S corporation or a C corporation.
Summing up, then, LLCs offer businesses and investors (and especially small businesses) a couple of big benefits: simpler governance and tax flexibility. And the people that appropriately choose an LLC are probably always basing the decision on either or both of these factors.
But a traditional corporation can sometimes make sense, too, as I discuss next.
Reasons to Choose Corporation Option
I think 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, as briefly discussed below:
1. “Branding” associated with a traditional “corporation.”
Some people (and some customers and vendors) think that a corporation is just plain more legitimate. These people also think that a business name that uses corporate acronyms is more legitimate and credible. In other words, these people think that names like “Acme Corporation” and “Percheron Hill, Inc.” sound or read or look better than “Acme Limited Liability Company” or “Percheron Hill, LLC.” This is probably a mostly psychological point–and an easy one to respond to: If someone just for almost emotional reasons wants a corporation (or wants words or acronyms like “inc,” “corp,” “incorporated,” or “corporation” in the business name), the business needs to be a corporation. Plain and simple.
2. Extra governance controls
The business I mentioned earlier about an LLC requiring less governance and an LLC allowing more informality? There’s a flip side to that coin. Some people (like outside investors who may have contributed startup funds) may want or benefit from the extra built-in controls that a traditional corporation provides. And in this case, one obviously wants to use a regular corporation. In other words, if the owners want regular stockholders meetings and if the entity needs to be governed by a board of directors and if day-to-day operations need to be delegated to corporate officers, well, of course, you may as well select the corporation option.
3. Desire or need to be treated as a C corporation
The extra tax accounting flexibility that an LLC offers its owners sounds great in theory, obviously. But in a situation where the entity wants to be taxed as just a regular corporation (also known as an C corporation), one doesn’t get any extra “tax flexibility” by going with the LLC. With the LLC that you want to be treated as a C corporation, one of your first formation steps will be to file paperwork with the Internal Revenue Service asking them to treat your LLC for tax purposes as a C corporation. With a traditional corporation that you want to be treated as a C corporation, you won’t have to do this extra work. The traditional corporation will initially automatically be treated as a C corporation. In this case, then, going with a corporation right from the start makes most sense and saves you paperwork.