LLC or corporation: Which is right for you?

Fifteen years ago, most business entities formed for liability protection were corporations. Most small, closely held corporations would elect s-corporation status to avoid the double taxation of a c-corporation and be taxed as a pass-through entity. However, s-corporation tax status has pitfalls. An s-corporation may only have one class of stock and may only have individuals that are U.S. citizens as investors. An s-corporation must also allocate profits and losses in strict accordance with its share ownership. S-corporation tax status can therefore be restrictive when raising capital or attracting investors. S-corporations are especially restrictive where investors demand preferred economic rights (such as preferred stock) or convertible debt, stock options or warrants.

Today, most small businesses entities that are formed for liability protection are limited liability companies (LLCs). A small, closely held limited liability company has the same liability protection as a corporation, but has more options for tax treatment. A limited liability corporation may be taxed as c-corporation or an s-corporation or a partnership. Many times, partnership tax treatment is a very advantageous form of tax treatment because it offers maximum flexibility to the business. A partnership does not have restrictions on its owners so members of an LLC taxed as a partnership may be business entities or non-U.S. citizens. A partnership may also allocate profits and losses with much more flexibility than a corporation through special allocation provisions. Special allocation provisions are allowed in partnerships because there is not a restriction on classes of stock.

A limited liability company taxed as a partnership is especially beneficial for businesses that need to attract foreign investors as equity owners or for two corporations or other business entities to engage in a joint venture without directly incurring the liabilities of the joint venture. A limited liability company taxed as a partnership is also advantageous for start-ups that need to attract angel or venture capital investments that may require a class of preferred membership with preferential economic rights, convertible debt or the issuance of options or warrants.

For more information about the differences between corporations and LLCs, please contact Andrew Miller, at MPL Law Firm, amiller@mpl-law.com.