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  1. Corporation or Limited Liability Company?

Corporation or Limited Liability Company?

We are often asked the question of whether to establish a new company in the form of a corporation or limited liability company.  This is a very complex question, involving many factors, including anticipated tax and growth issues.  Therefore, you should always consult with your particular advisors.

As a general rule, our office follows some guidelines for general discussion:

        1.  Corporations and limited liability companies are legal entities with presumed limited liability protection for the shareholders.  However, the corporate entity has a tried and true existence for many years and, all things being equal, remains our entity of choice.  Corporations offer great flexibility and protection. Corporations are the entity of choice to "go public" in an initial public offering.  Corporations also offer tax qualified stock options (ISO's).

        2.  Corporations have the detriment of "double taxation"; that is, for $100 of profit, the corporation pays an income tax, then the remainder that is distributed to shareholders is taxed again to the recipients.  This is effectively like being in the 55% tax bracket.  For smaller businesses, a corporation and make a Subchapter S election.  This tax election, called an "S" election, or S corporation, allows the corporation to be taxed similarly to a partnership.  Partnerships themselves do not pay taxes, but the income "flows through" the corporation and is taxed directly to the partners at their personal tax rate, on a pro-rata basis relative to ownership of the partnership.  S corporations offer the best of both worlds: limited liability and taxation like a partnership.

        3.  The downside of an S corporation is that it is limited to one class of stock, 75 shareholders, no non-resident alien shareholders, no corporate shareholders under certain circumstances.  Usually, it is the one class of stock and corporate shareholder issue that presents challenges for structuring.

        4.  LLC's are technically historically partnerships with limited liability.  Therefore, LLC's are taxed as partnerships, unless you prefer otherwise.  As the same time, LLC's do not have the long legal history such as corporations.  LLC's have only been recognized as legal entities in more recent years.  And, for many years, taxation of LLC's was in dispute.  Therefore, the case law relating to taxation and governance is less assured.  Unlike the LLC statute, the corporation statute has much more definitive rules, and a long history of case precedent.

        5.  Where LLC's perform best is when an S corporation will not work because flexibility is required in structuring, such as two classes of stock.  However, because LLC's permit such great flexibility, care must be taken in the structuring.  A blank slate can be a good thing or bad thing, depending upon the circumstances.  LLC's present excellent opportunities for joint ventures.

        6.  That said, here's a common thought process:

                a.  A single resident shareholder. No plans to have corporate shareholder.  No need for multiple classes of stock.  No fancy structuring.  A simple small business desiring limited liability.  We often recommend S corporations.

                b.  Any time an S corporation will not be available and the flow through tax is desired, then we often recommend an LLC.  If the client has the goal to become a public company, then it is a trade-off between a C corporation or temporarily an LLC until the IPO.

We know of some firms that recommend LLC's for all purposes because of the flexibility.  We do not share that perspective.  LLC's are very flexible entities for structuring, but, if the flexibility is not needed, then the LLC creates risk, particularly for a single member LLC.  S corporations have, of course, worked splendidly for many years.

Therefore, in short, we start with the presumption of forming limited liability entities in the form of S corporations, then evaluate the particular circumstances of our client to determine if we should override the presumption for an LLC. 

Our office establishes many corporations, s corporations, LLC's, partnerships, limited partnerships, etc., for our clients and would be glad to assist you with implementing your business goals.

See also our publication on Corporate Structure and Choice of Entity.

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If you have any questions, please contact us at 412.765.0400 or info@zegarelli.com.

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Articles and information are for general information only. You should not rely upon any information provided by or on the website, including articles, as applicable to your particular situation. The law, filing fees, etc., change often, so the information in this document may not be current. The laws of various jurisdictions may be different than provided here.  Please contact us at info@zegarelli.com if you are interested in becoming our client--only then would this office be in the position to provide advise with regard to your particular situation.

Unless otherwise specified above, Copyright © 2004,2008 Technology & Entrepreneurial Law Group, PC. All rights reserved.




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