LLC or Corporation – how do I choose?

There are four common types of businesses in the USA: Sole proprietorship, partnership, limited liability company (LLC) and corporation (both C-Corps and S-Corps). What are the differences and how do you know what to choose?

Businesses are classified as either:

• Registered businesses (LLCs, corporations, and certain partnerships)
• Unregistered businesses

Registered businesses require you to provide documentation to your state government and comply with certain filing and legal requirements. But in exchange, you get “limited liability.” This is a big deal.

If you simply start doing work on your own without any registration, you are a sole proprietor. You limit your liability through insurance. But if you get sued and your insurance doesn’t protect you, you may lose your house, savings, and other personal possessions.

If you start working with a partner and don’t register, you are a standard old-fashioned partnership. This is not a good plan under any circumstance in today’s world. Each partner has unlimited liability, including for the other partner’s mistakes. In almost every case, we suggest instead using an LLC. But the benefit of a partnership is simplicity. Again, you can use insurance to limited your liability.

LLC vs Corporation

Both LLCs and Corporations require registration with the state government. You get limited liability, meaning if you manage the businesses properly, you will not be personally responsible for the problems of the business.

Corporations have been around for centuries and the laws have been tested and refined over a long period of time. There are many laws that govern corporations and the laws and legal requirements are well understood. Corporations tend to have more complex requirements for staying compliant.

Limited liability companies have only been around since the 1970’s and 80’s. Instead of being controlled by a set of strict laws, LLCs are controlled by a contract called an operating agreement. The laws for LLCs tend to be brief, simple, and act as a default behavior with most of them fall backs in case the LLC’s operating agreement doesn’t address an issue. Since the oldest LLCs are less than 50 years old, the laws and court cases have not been tested.

Choose a Corporation if You Want Rigid Structure

When a company is dealing with investors who are not actively involved in the business or when there are strict requirements for the operation of the business, then an corporation is the best choice. Since the regulations for corporations are well understood and there are strict requirements for operating a corporation, they are strongly favored by investors.

It may seem odd that complexity is a benefit. However, when a company is publicly traded on the stock market or when it is seeking investors, there is safety knowing that the officers of the company must follow certain rules. There are other reasons to choose a corporation, but typically it’s in situations where compliance is an issue—particularly tax compliance.

Use our Advanced Business package or Launch 360 plan to create a corporation.

Choose an LLC if You Want Flexibility and Simplicity

LLCs are simple to set up and because they are controlled by a contract, anything that is valid for a contract can be valid for governing an LLC. In many states, the cost to start an LLC is low. The operating agreement is strongly suggested but not required, meaning some people without legal experience can file their own.

If you have a small business, a family business, or a partnership, an LLC is a good idea. The amount of ongoing effort to stay compliant is very low, so you can focus on running your business.

Use our Basic Business package, our Advanced Business package, or the Launch 360 plan to start an LLC.

What About Partnerships?

Partnerships present extra risk and some advisors suggest against them. We think partnerships can be a fine idea, but it is best to work with us to plan it out. We can help you create documents and plans that avoid some of the most common partnership problems. Sadly, partnerships that are not well planned too often lead to friendships and family relationships being torn apart because of business disputes.

You can register a partnership to get limited liability, but we suggest instead forming an LLC. It is either less work or no more work to do an LLC and it provides very clear liability limits.

Some situations where a partnership is better: A “joint venture” between businesses, for example two LLCs or corporations, can make for a fine partnership. Also, if an unregistered partnership wants limited liability, it can often be upgraded to a limited liability partnership. This can be handy when the partnership has certain licenses that would be lost of a new business entity is created.

Use our Advanced Business package or Launch 360 plan to create a partnership.

What’s the Difference Between an S-Corp and a C-Corp?

Many people are confused about S-Corps. An S-Corp is not a type of business, instead it is a way of being taxed. An LLC defaults to be taxed as a sole proprietorship or a partnership. A corporation defaults to being taxed as a C-Corp. However, both an LLC and a Corporation can change their tax status to be taxed as an S-Corp if they qualify. This can improve their tax situation. We can help you elect the S-Corp status.

Legally, an LLC taxed as an S-Corp is still an LLC to everyone except the IRS. And legally, a corporation taxed as an S-Corp is still a corporation to everyone except the IRS. Changing your business’s tax election to an S-Corp does not change the type of business you have. So you would not normally say “I have an S-Corp.” Instead, if anyone you talk to needs to know this, you’d say “My LLC is taxed as an S-Corp,” or “My corporation is taxed as an S-Corp.” But that sounds nerdy, so don’t say that.