You may here people say you should “incorporate” or even hear LegalZoom or some other company advertising about “creating an S Corporation” or an “LLC”, in a sea of entity choices, which is right for you and why?
The answer is simple, Limited Liability Company (the “LLC”) is the choice for 99.99% of businesses, family estate planning vehicles, asset protection and investment vehicles. In fact, you have to convince me why any other entity is right for your situation (and I’m happy to debate you on that)!
For the sake of keeping things simple, let me explain the three reasons that the LLC are the single greatest gift that state legislatures have ever given to business:
- Management:
What this means is literally, how does the state require you to, or otherwise allow you to operate your business? I know what you’re thinking: can the state dictate to me how I operate my business, and does the state care about how I operate my business? The answers are: Yes and Yes! In fact, “how you operate your business” is the number 1 reason for both (1) IRS tax issues and (2) “piercing the veil”, where your LLC does not protect you from legal liability.
So what makes the LLC’s management the best? YOU GET TO DO WHATEVER YOU WANT! Literally, if you can put it on paper, you can do it. What this means is that if you want to have 1 vote per person, and majority of votes rules, you can do that. If you want to have one person get to veto anything, you can do that. If you want to have weekly meetings or no meetings every, you can do that! Run your company how you want to run your company, provided you have the paperwork to explain it (the “Company Agreement”, this is what places like LegalZoom do NOT give you).
So what about other entities? Let’s look at the corporation for example: in a corporation, you must do the following to say, open a bank account for the company:
- Have the board call a meeting (this is just you at the meeting);
- Propose a resolution to the shareholder(s) at this meeting to open a bank account (again, just you);
- Give this resolution to the shareholder(s) (assume you are the only shareholder) for shareholder approval;
- You, as shareholder; hold a vote with yourself to approve the resolution;
- The board passes the resolution upon shareholder approval;
- The board instructs the CEO to execute the resolution (again this is you);
- The CEO instructions a manager to execute the resolution (you again);
- The manager instructs the employee of the company (you) to go open the bank account using the paperwork from the board.
- All of these items are recorded in the “Corporate Minutes” record book.
Sound ridiculous right? IT IS! But, it’s the law, and most of you have already violated this law without even knowing you had to comply. And for this, you can lose your company! The great thing about LLCs are that their “default” is “do what you want”, any other entity default is “do what the state told you to do”. Now, what if you wanted your LLC to operate like a corporation and have all 9 steps from above? You can do that with an LLC too! Key takeaway, an LLC can do ANYTHING that a corporation can do, a corporation CANNOT do everything that an LLC can do.
- Taxes:
This should be the most important reason for business owners. An LLC gets to “check the box” and literally tell the IRS how to treat it, how many of you want to be able to tell the IRS how to treat you?
What do I mean? If your LLC has only one member (you are the only owner), it defaults to a “disregarded entity” for IRS purposes, meaning the IRS does not see your LLC and you simply file a Schedule C. If your LLC has more than one member, it defaults to a partnership for IRS purposes. Neither of these entities pay any taxes, they “flow through” profit/loss to you the owner(s)! That’s great, the LLC default is a “pass through” tax!!!! Want to change to a “C” Corp or an “S” Corp? Great, an LLC can do that too!!!
Now, what about the corporation? It defaults to “C” Corp status, meaning you are taxed twice: once at the corporate level (at 35%) and once again at the shareholder level (at 23.8%) for a total tax rate of 58.3%, that’s a lot higher than the 39.6% highest you’d pay with an LLC!
Can a corporation ever “pass through”? Yes, but only with the “S” Corp election, which is not as flexible as a partnership and has restrictions on who can use it and when they can use it.
- Charging Order (Asset Protection):
This is the absolute holy grail of asset protection, and it is ONLY available to the LLC. A charging order works like this:
I have an LLC:
I hurt you doing my business (say I’m a lawncare business and I run over your foot), you can have everything in my lawncare business, but none of my personal assets.
I hurt you unrelated to my business (say I run you over on my way to the grocery store), you can NOT have my business, only my right to profits from my business, BUT you cannot force me to actually pay my profits…so you may never get anything from me.
I have a Corporation:
I hurt you doing my business (say I’m a lawncare business and I run over your foot), you can have everything in my lawncare business, but none of my personal assets.
I hurt you unrelated to my business (say I run you over on my way to the grocery store), you can take my corporate stock, meaning, for running over you on my way to the grocery store, YOU CAN TAKE AWAY MY BUSINESS FOR SOMETHING UNRELATED TO MY BUSINESS!!! If you provide for your family with your business income, how would you survive this?
The takeaway here is that the LLC offers FAR MORE PROTECTION THAN A CORPORATION EVER COULD!!!!
