Choosing Between LLC or Corporation for Your Startup
Choosing Between an LLC or Corporation for your Startup
Choosing a business structure for your startup can be a complex and difficult decision. There is no “one-size-fits-all” entity type and choosing the right structure is crucial for the long- and short- term trajectory of your business. Tax implications, management structures, investment opportunities, growth goals, and operation formalities are relevant factors when choosing how to structure your business. Understanding the key aspects of different business structures will help guide you in analyzing these concepts and ultimately help choose the best structure for your specific business.
Limited Liability Companies
A Limited Liability Company (“LLC”) is a business structure that mixes elements of corporations and partnerships which gives owners flexibility and protection. LLCs are simple structures that are easy to start and maintain. Key aspects of an LLC include: (i) limited liability for its members’ personal assets if the business incurs debts or legal liabilities, (ii) pass-through taxation which allows LLC profits and losses to flow through to the owners to be reported on their individual tax returns (no “double taxation”), (iii) more flexibility in terms of operation and governance with fewer requirements for meetings and recordkeeping, (iv) ownership and transfer flexibility in eligibility of individuals and entities in obtaining membership interest, and (v) choice in management structure (member-managed v. manager-managed).
LLCs are typically easier to manage and maintain when compared to a corporation. An LLC doesn’t have as many ongoing compliance and governance standards as corporations, such as required meetings, management structures, required compliance filings, etc., which in turn makes an LLC more cost efficient. In addition, the pass-through taxation aspect of an LLC adds no additional tax filings to the owner’s individual taxes and allows the owners to offset any LLC losses against their own personal income. This taxation structure does add an additional tax obligation as most members will need to pay self-employment taxes on the reportable income from the LLC on their individual tax returns, however, LLCs do not carry the “double taxation” aspect that corporations have.
Corporations
A Corporation is a business structure that is created and becomes a separate “person” for legal and tax purposes from its owners. Corporations are more complex and rigid due to more formal operating procedures. Key aspects of a corporation include: (i) limited liability from its owners’ personal assets if the corporation incurs debts and legal liabilities, (ii) “double taxation” which taxes the corporation first on the profits and losses (corporate tax rate) and then imposes a second tax on distributions made to the shareholders on their individual tax return (unless S corporation entity election is chosen), (iii) formal management structure that includes shareholders (owners of stock), officers, and a board of directors, (iv) rigid operation and governance with requirements for meetings and recordkeeping, and (v) a perpetual existence.
Corporations allow for quick growth and are typically known for attracting outside investors and employees. Even though corporations have the “double taxation” aspect that LLCs do not have, corporations are eligible for federal tax deductions that are only available to corporations, so the additional tax is not so burdensome. In addition, investors are inclined to invest in corporations more because they receive stock in the corporation and do not have to worry about filing the corporation’s profits and losses on their individual tax returns. Investors also have IRS incentives to invest in corporations by receiving federal exclusions on their individual tax returns, such as a section 1202 exclusion which allows for a 10-million-dollar exclusion on capital gains from the sale of qualified business stock. Corporations tend to have improved business function as the rigid requirements for managerial procedures ensure smooth and monitored operation. Finally, corporations offer equity incentive plans, such as stock options, that attract employees and long-term retention.
Key Factors to Consider when Choosing
Making the choice between an LLC and a corporation depends on your immediate business needs and long-term goals. It's vital to consider business factors like immediate setup needs as well as ongoing needs like long-term growth. Crucial factors to consider when trying to determine whether an LLC or corporation is the right choice for your startup include Taxes, Management Structure, and Growth Potential.
Taxes
The tax structure is one of the biggest distinguishing factors between corporations and LLCs. Many startups are attracted to the pass-through structure of an LLC, which allows owners to report profits and losses on their individual tax returns and offset losses against their personal income. Corporations are known for double taxation on distributions and a more complex tax structure but have more deduction and exclusion opportunities available only to corporations.
Management Structure
Your management expectations will help you decide which entity best meets your business needs. LLCs offer a flexible management style with fewer requirements and the choice of being member-managed or manager-managed. Corporations have stricter management requirements and higher costs as a result but can lead to improved management of your business.
Growth Potential
When rapid growth is your top priority, a corporation is usually the preferred entity. While you can add members to an LLC, investors typically prefer corporations because of their ability to issue stock.
Learn More About the Services We Offer
Choosing between an LLC and a corporation is only one of many important legal decisions startups need to make. When you want proactive and efficient service dealing with your biggest challenges, an experienced business attorney can help. Strauss Troy Attorneys have strong records of providing innovative solutions to complex legal challenges for businesses of all shapes and sizes in Cincinnati and Covington, KY. Check out our full line of legal services for businesses.
* An S corporation is a business structure that employs corporation formalities but adopts the tax implications of an LLC. An S corporation requires (i) a U.S. corporation, (ii) one class of stock, (iii) maximum of 100 shareholders, (iv) restrictions on shareholders, i.e., LLCs cannot be shareholders, (v) all shareholders must have valid US Social Security number. For more details on S corporation structures, contact our business and tax attorney group.
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