Deciding what structure is right for you is an indispensable step in forming a new business. When it comes to forming your business, the business structure that is right for you will depend on your personal circumstances and preferences. This article discusses the difference between limited liability companies (LLCs) and corporations.
To form a corporation in Texas you must file a Certificate of Formation with the Secretary of State’s office. This means that you also need to pay a registration fee (currently $300 in Texas). You will also be required to obtain proper licenses and permits.
Forming a corporation can be a lot more complicated than forming an LLC. But, the extra effort can be worth it in the long run.
A Texas corporation must have:
- A qualifying corporate name;
- Directors to oversee the affairs of the company and approve transactions;
- Officers to manage the daily operations;
- Shareholders to have ownership in the company;
- A qualifying registered agent for service of process in the state; and
- Corporate bylaws that govern the basic ground rules for operating the corporation.
Corporations must comply with more regulations and tax requirements than an LLC because the owners enjoy a greater deal of personal liability protection. Corporations also offer certain tax incentives that LLCs do not. These tax advantages relate, for the most part, to tax deductions and employment taxes and can save a company thousands of dollars per year.
How your corporation pays taxes will be determined by whether you file as a C-corporation or an S-corporation. C-corporations pay taxes at the corporate income rate and their shareholders are taxed personally on any distribution or dividends they receive from the corporation. This is referred to as double taxation.
S-corporations, on the other hand, are pass-through entities, meaning that they are treated like sole proprietorships and partnerships for tax purposes. Sole proprietorships and partnerships report all of their income as regular income on their owners' individual tax returns. There are limitations on what can qualify as an S-corporation, but most small businesses qualify.
Finally, because of their ability to be bought and sold in stocks or shares, corporations are the preferred business structure for outside investors and for IPOs.
Limited Liability Companies (LLCs)
An LLC offers a great deal of flexibility in terms of the management and operation of your business, like a partnership, but with the personal liability protection of a corporation. The catch is, however, some LLCs face reduced asset protection and the case law regarding LLCs is less developed than that for corporations.
To form an LLC, you must file a Certificate of Formation with the Secretary of State's office, similar to that for a corporation. Also, you will have to register a legal business in the state where your LLC is formed and obtain the necessary licenses and permits.
Texas does not require you to write an operating agreement for your LLC, but it is recommended that you do so. This way you will have clearly defined rules and regulations to which your business operations can adhere.
As the name suggests, the owners/members of an LLC enjoy limited personal liability when it comes to business decisions and actions taken by the company.
Generally, an LLC is taxed like a sole proprietorship or partnership and income is passed through to its members as ordinary income. However, the LLCs members may choose a different tax treatment.
Single-owner LLC can be taxed as a sole proprietorship or a corporation. LLC with more than one member can be taxed as either a partnership or corporation.
An LLC that chooses corporate tax treatment can choose to be taxed as a C-corporation or an S-corporation.
LLC or Corporation: Which is right For You?
Each type of business structure has unique pros and cons when comes to:
- Operating structure;
- Registration and filing fees;
- Maintenance requirements;
- Liability protection; and
Make sure to consider these criteria when determining which business structure is right for you. For instance, you may note that LLCs and corporations are similar in that they both:
- Protect their owners' personal assets from business liability
- Are considered separate entities, apart from their owners, which requires the owners' personal finances and the finance of the business to be kept separate.
- Are allowed in all 50 states and the district of Columbia
However, an LLC offers a more flexible management structure, has more flexible tax reporting options, and is generally considered much easier to maintain than a corporation. On the other hand, a corporation offers certain tax credits that an LLC does not and can go public to raise money.
So, when deciding between a corporation and an LLC, you may first want to consult with your tax advisor regarding which structure offers the best tax advantages for your company.
Next, you want to consider whether you have plans to take your company public. If so, you may prefer a corporation because with a corporation you can issue shares of ownership. What’s more, investors are more attracted to corporations.
It should also be noted that if the type of entity that suits your business the best changes over time, you can file a conversion to change entity types.
For help with choosing between a Texas LLC and a Texas corporation, consult with an experienced Texas business advisor.