Lubbock & Amarillo, TX LLC & Corporate Attorney
LLC & Corporate Roulette – Which Entity to Choose?
Having met with clients, large and small, over 29 years – most have very little understanding as to which entity should be selected in forming a new business. Typically, the clients will attempt to review articles on the subject and come out even more confused than when they started out. Here’s a quick primer on the subject to guide you along the path of business formation.
1. Do NOT form a “C Corporation” unless you received good legal advice.
“C Corporation” status subjects the new business to double taxation which is a horrible result. Although this type of entity will shield the owners from personal liability (subject to the exception noted below), it comes with a steep price. Funds which have accumulated in the bank account for the C Corporation are subject to taxation by our friends at the IRS. Additionally, distributions to the owners whether paid by dividend or payroll are also subject to taxation. This unfortunate situation which can cripple a new business is referred to as “double taxation”. However, there are certain tax and organizational benefits for C Corporation status which may in very rare situations outweigh the adverse tax consequences. If so, your attorney and accountant will advise accordingly.
2. Choose Option 1 (LLC) or Option 2 (S Corporation)!
Let’s assign LLC status to option 1 and start with that possible choice. Most transactional attorneys will recommend that new businesses set up legal status as a limited liability company (LLC). An LLC has all of the benefits of a corporation but without the detriment of double taxation and formalities of a corporation. Unlike an “S Corporation” (our option – 2), the LLC requires relatively simple legal documents to be executed between the owners and filed with the State of Texas. A big plus is that the paperwork required to maintain an LLC is substantially less than what is required for S Corporations. Less paperwork means less headache and time spent at the attorney’s office. I always tell my new business clients that you want to reduce your legal expenses to a minimum during the first year of operation and I am dead serious about that! An LLC will definitely facilitate that goal. The other decided benefit of an LLC is that it is a “Pass Through Entity” which means that your business bank account is not subject to double taxation. You only pay taxes on what is actually paid to the owners. That benefit is usually all the new client has to hear to choose an LLC.
3. S Corporations as another option.
There is nothing wrong with choosing an S Corporation as it will also avoid double taxation problems and protect the owners from personal liability. The only reason not to select this entity is the increased level of paperwork involved. S Corporations require that Amendments to the Bylaws and other corporate documents be maintained over the life of the business. This often creates additional work and expense. Best to travel light if you can!
4. Tricks of the LLC – S Corporate Trade.
Whether you select and LLC or S Corporation, the owner will be protected from personal liability. However, failure to set up the entities properly or sloppy accounting can jeopardize that status. If there is a defect in the formation of the entity, it will lose its protected status and default to a sole proprietorship which always imposes personal liability on the owners. Although I am definitely not disinterested, I would stay away from the internet services which promise to set up your entity with a few clicks. It’s more complex than that. Also – most Law Firms do not charge substantial fees to set up an LLC or S Corporation as it is not a complex task for transactional attorneys – just the clients! Some of the online services are actually more expensive than traditional attorneys.
Also – once the entity is set up, the owners cannot treat the bank account as their personal piggy bank. The business account must be kept separate from the personal account. Never should the twains meet. If a clear line of demarcation is not drawn between personal and business activities, a lawyer on the suing side can attempt to “pierce through the corporate veil” and sue the owners directly. If successful, the owners will lose their protected status from liability.
Finally, make sure that you consult an attorney to have a proper agreement set up between the owners. An S Corporation has an agreement known as a “Shareholders Agreement” whereas it is referred to as a “Company Agreement” for an LLC. These agreements determine the rights between the owners with regard to selling the corporation to third parties, divorce or death of the owners, and other critical issues. In the absence of working these issues out at inception, owners risk expensive litigation down the line if disagreement arises. And they do!!
Get good legal advice before selecting an entity and stay away from the web!