A Limited Liability Company (LLC) is similar to a corporation to the extent that they both allow you to start a business that can protect you from personal liability. An LLC is very popular today and easier is some respects than forming a corporation. Below is listed a brief overview of advantages and disadvantages of having an LLC for your business.
Advantages of an LLC
- Fewer corporate formalities. An LLC requires less business formality than a corporation. Corporations must hold regular meetings of the board of directors and shareholders, keep written corporate minutes. If you fail to document or follow the proper business procedures, a creditor may be able to pierce the corporate veil and hold the shareholders personally liable for corporate actions. The members and/or managers of on LLC does not need to hold regular meetings, which can reduce the complications and the paperwork.
- Special profit allocations. An LLC can make special allocations of profits and losses among members that can be different from their percentage ownership. An S corporation cannot make special allocations of profits and losses. S corporations must have one class of ownership in which profits and losses are allocated according to the percentage of ownership.
- Tax flexibility. By default, an LLC I treated as a “pass-though” entity income tax purposes, similar to a sole proprietorship or partnership. This means that an LLC may avoid certain double taxation issues. However, an LLC can also elect to be treated like a corporation for tax purposes, whether it is a C corporation or S corporation.
- No ownership restrictions. An LLC may have an unlimited number of members, whereas an S corporation is limited to one hundred. The owners of an LLC can be foreign persons, other corporations, LLCs, or any kind of trust, but the owners of a corporation should not be.
- Ability to use cash method accounting. Most LLCs can use the cash method of accounting. This means that income is not earned until it is received. Most C corporations often must use the accrual method of accounting which means that income can be earned before it is received.
- Ability to deduct losses. Member who are active participants in the LLCs business can deduct its operating losses against the member’s regular income to the extent it is permitted by law. Shareholders of a S corporation are able to deduct operating losses, but shareholders of a C corporation are not allowed to deduct operating losses against their income.
Disadvantages of an LLC
- Profits are subject to Social Security and Medicare Taxes. For an LLC that is disregarded for tax purposes, there can be the disadvantage that all earned income is subject to the self-employment tax, unlike in an S corporation win which some money can be taken out as salary and some as dividends. Hoer, the LLC can opt to be taxed as a corporation and then opt to be taxed as an S corporation.
- Owners must immediately recognize profits. Unless an LLC elects to be taxed as a corporation, profits are automatically included in a member’s income. A C corporation does not have to immediately distribute profits to its shareholder as a dividend. This mean that shareholders in a C corporation are not always taxed on the corporation’s profits.
- Personal liability for payroll taxes. The owners of an LLC that is taxed as a disregarded entity (like a sole proprietorship or partnership) can be personally liable for payroll taxes that are not paid by the company. Shareholders of a corporation would not be liable for these taxes unless they were officers or directors.
- Fewer fringe benefits. Employees of an LLC who receive fringe benefits, such as group insurance, medical reimbursement plans, medical insurance and parking, must treat these benefits as taxable income. However, C corporation employees who receive fringe benefits do not have to report these benefits a taxable income.
All tax issues for an LLC or a corporation should be reviewed by a CPA. This is not a comprehensive list of advantages or disadvantages of and LLC vs. a Corporation, but only gives a brief overview of some of the basic differences. You should talk to your attorney and CPA about what makes the most sense for your business.
Susan J. Taylor is a Houston-based commercial litigation and business law attorney. She began practicing law in Texas in 1985 with a primary concentration in business, real estate, and commercial litigation and bankruptcy. Ms. Taylor is Board Certified in Civil Trial Law by the Texas Board of Legal Specialization. For expert help with commercial litigation or business law issues, please contact The Taylor Law Group for a consultation.