Business owners and startups are often flustered when choosing the structure of their enterprise. When starting a business, one of the most critical decisions you’ll make is choosing the appropriate business structure. This decision will impact your day-to-day operations, tax obligations, and your personal liability. Two of the most popular business structures are the Corporation (typically an S-Corp or C-Corp) and the Limited Liability Company (LLC). Each has its benefits and considerations, making it essential to understand which is best suited for your business goals and needs.
These two basic ones are covered below, but know that there are other types of business structures like limited partnerships. If you aren’t sure which structure is best for your unique business, don’t panic. A Houston corporate attorney will help you choose the structure optimal for your unique enterprise.
An Inside Look at LLCs
Advantages of an LLC
- Flexibility in Management: LLCs offer a flexible management structure. Unlike corporations, LLCs do not require a board of directors, allowing owners (members) to manage the business directly.
- Pass-Through Taxation: Typically, LLCs benefit from pass-through taxation where the business income passes through to the owners’ personal tax returns, thereby avoiding the double taxation often associated with C Corporations.
- Fewer Formalities: LLCs are not subject to the same rigorous record-keeping and meeting requirements as corporations, making them easier to maintain.
- Limited Liability: If the LLC is sued, to the extent the owner has not taken any action that would otherwise give rise to a “veil piercing argument”, the LLC’s owner is not liable, only the assets of the LLC.
Considerations for an LLC
- Limited Growth Potential: Raising capital can be more challenging as LLCs cannot issue stock. This might limit the attraction to investors, especially venture capitalists.
- Varying State Laws: The rules governing LLCs can vary significantly from state to state, potentially complicating interstate business operations.
LLCs are formed with the filing of paperwork with the Secretary of State. The legal document functions as the framework for the company’s operations. Though few are aware of it, LLC ownership is held by members. Each individual member owns a specific percentage of the LLC, referred to as a membership interest in the enterprise.
Meet with a Houston corporate attorney and you’ll find it is possible to form an LLC with a single owner referred to as a single-member LLC. Your attorney will also educate you about the nuances of forming a multi-member LLC with several owners.
The number of LLC members is limitless, meaning eligible parties include:
- Individuals
- Foreign entities
- Other LLCs
- Corporations
Let’s shift our attention to the creation of a corporation.
Forming a Corporation
A corporation is formed with an official document referred to as the Articles of Incorporation. The Articles are filed with the state government. The Articles are to be crafted by a Texas corporate attorney to contain specific provisions. Corporate bylaws are established to govern the company’s management and shareholder rights.
Corporation owners are shareholders. The purpose of shareholders is to invest assets and money into the company in exchange for shares of stock that constitute ownership. The number of owners in a corporation is limited to the number of shares.
Advantages of a Corporation
- Raising Capital: Corporations can raise capital more easily through the sale of stock, which can be appealing to investors.
- Perpetual Existence: Corporations continue to exist even if the owner leaves the company or sells his or her shares, which can provide stability and ongoing business continuity.
- Credibility: Incorporating can provide a perception of credibility and permanence to a business, which can be beneficial in dealing with suppliers, creditors, and potential clients.
Considerations for a Corporation
- Double Taxation (C-Corps): C Corporations are taxed at both the corporate level and again at the individual level on dividends, leading to double taxation.
- Regulatory Requirements: Corporations face more stringent regulatory requirements, including mandatory annual meetings, detailed record-keeping, and reporting obligations, which can be cumbersome and costly.
- Complexity in Tax Filing: The tax filing requirements for corporations are more complex than for LLCs, potentially requiring more expensive accounting services.
S Corporation Consideration
- An S-Corp is a special type of corporation created through an IRS tax election. It combines the legal environment of a corporate structure with the tax benefits of a pass-through entity. However, it comes with restrictions on the number of shareholders and who can be a shareholder.
Taxation: LLCs vs. Corporations
The decision between structuring a business as a corporation or an LLC often comes down to taxes and legal liability. The default taxation of a corporation is that of a C-corporation in which corporate taxes are paid in addition to shareholders’ profit taxes. Such double taxation can be avoided with the formation of an S-corporation.
S-corporation profits move through the personal tax returns of shareholders, subject to a reasonable salary being first paid to shareholders. Shareholders pay taxes on the profits. Your Texas corporate attorney will advise you on how to qualify as an S-corporation.
If you prefer more flexibility in terms of how the business is taxed, consider the merits of an LLC. LLCs are not officially classified with IRS tax classification. Rather, sole proprietorship taxes are applied to LLCs of the single-member variety. The default taxation for a multi-member LLC is that of a general partnership.
LLC formation prevents the dreaded pass-through taxes, helping business owners sidestep double taxation. The business’s profits move through members. Members pay self-employment taxes and income taxes.
LLC or Corporation? That is the Question
In short, LLCs are favorable for limited liability, less taxation, and minimal bureaucratic regulation. Corporations are ideal if one aims to sell ownership in the enterprise, generate outside investment interest, or possibly go public with the company down the line. Remember, we are only comparing these two types of entities in this post. For more sophisticated business owners, see our post on limited partnerships.
Learn More During a Consultation With Our Houston Corporate Attorney
The structure you select for your new business plays a significant role in determining its fate. A corporate attorney will help you choose the right structure for your enterprise. Contact us today to schedule a consultation.