One of the first big decisions you need to make when starting a business is what legal structure to adopt.
Many people choose to operate their businesses as sole proprietorships or general partnerships.
While these structures are simple and require no formal corporate filings, they offer little protection from legal liability. For that reason, many entrepreneurs opt for a more formal entity such as a corporation or a limited liability company (LLC).
You may have some questions about the differences between LLCs and corporations. Here is a brief sketch of the relative advantages and disadvantages of each.
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LLC vs Corporation: How They Are Formed
You form a corporation or LLC by filing a “certificate of formation” with the Texas Secretary of State. The certificate contains the basic information about your business entity, including its legal name and the name and address of a “registered agent,” a person or business within the State of Texas that is authorized to receive legal papers on the entity’s behalf. You can serve as your own registered agent provided you actually live in Texas.
LLC vs Corporation: Legal Identity and Liability
Corporations and LLCs are both considered legal “persons” with identities separate from any of the individual owners. Most importantly, this means that the corporation or LLC can “sue and be sued” in its own name. This generally protects the owners from personal liability for any business-related debts. The owners’ liability is limited to their interest in the business itself.
LLC vs Corporation: Number and Types of Owners
One person can form an LLC or corporation. There is also no maximum number of owners for either an LLC or a C-corporation (more on that in a moment). Owners of a corporation are typically called “shareholders,” while in LLCs they are “members.”
There is a special type of business entity known as a Subchapter S Corporation. An S-corporation is similar to a C-corporation except that in order to receive certain tax advantages, there is a limit on the total number of shareholders.
LLC vs Corporation: Governance and Management
Here is where you start to see a clearer distinction between corporations and LLCs. A corporation must follow a more rigid structure: The shareholders elect a board of directors, who in turn appoint corporate officers to manage the corporation on a day-to-day basis. Texas law also requires corporations to keep certain records, including written minutes of shareholder and director meetings.
In contrast, an LLC affords members the flexibility to decide their own management structure and governance. An LLC usually has an “operating agreement,” which is a written contract between the members detailing exactly how to run the business. LLCs do not have to have formal corporate officers. The members often divide managerial tasks among themselves, although they may choose to adopt a more corporation-like structure and appoint a professional manager.
LLC vs Corporation: Taxation
This is the other major item separating LLCs from corporations. A C-corporation is subject to “double taxation.” First, the corporation pays income tax on its profits. If the corporation then distributes any profits to its shareholders in the form of dividends, those individual profits are taxed a second time.
An LLC, in contrast, is normally “disregarded” for tax purposes. This means the IRS acts as if the LLC never existed and the individual members report any business income as either a sole proprietor (in the case of a one-member LLC) or a partner in a general partnership. Hence, there is no double taxation as with a corporation. However, an LLC may elect to be taxed as a corporation.
One thing to keep in mind about a “disregarded” LLC is that it may result in a significantly higher self-employment tax on members who are also employees of the business. Normally a corporation pays one-half of an employee’s Social Security and Medicare taxes based on their salary. A “self-employed” person, such as an LLC member, must pay the full amount of these taxes based on their total share of the LLC’s profits.
LLC vs Corporation: Raising Capital
One final issue to consider is how your choice of entity will affect your ability to raise capital for your business. Corporations basically exist for this purpose. A corporation can have hundreds or thousands of individual shareholders. While an LLC can sell membership interests, it is usually not as efficient as a C-corporation when it comes to raising a large amount of capital quickly.
Need Advice on Organizing Your Business?
Choosing a business structure is just one of many legal decisions that your business will face. Our experienced Dallas business formation attorney can help you with all types of business matters from contracts to intellectual property. Call us at 214-382-9789 to talk to a lawyer now.