When Is it Better to Form an LLC Instead of a Corporation?

By David Ingram

LLCs and corporations are similar in a number of ways, but LLCs feature distinct advantages and limitations that make them best suited for specific types of organizations. Knowing when it is better to form an LLC instead of a corporation can help you to choose the ideal form of organization for your company.

Liability Risks

Companies in certain industries can find themselves at a relatively high risk of liability for legal actions or debts. Companies like pharmaceutical manufacturers, for example, can incur legal obligations in the millions of dollars for class-action lawsuits. If a company wishes to operate the same way as a partnership or sole proprietorship, but needs extra protection from personal liability, the LLC form of organization may be the right fit. LLCs provide liability protection without the possibility of losing control of the organization through the votes of stockholders, as can be the case with traditional corporations.

Tax Status

One of traditional corporation's most pronounced drawbacks is the concept of double taxation. Corporations, as separate legal entities, are taxed for their income, then the income is taxed again at the individual owner level. Business owners who wish to gain liability protection without incurring double taxation can take advantage of the LLC form, which allows owners the option to tax the business like a corporation or as a pass-through entity like a sole proprietorship.

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Stock Limitations

Unlike corporations, LLCs do not have the right to sell shares of stock to the public to raise money. Thus, LLCs are best suited to business owners who do not wish to take advantage of this fundraising method. Not having the ability to sell stock can impede LLCs' growth prospects compared with corporations, which can grow large quickly through stock and bond offerings. Because of this, the LLC form may be better suited to businesses that do not wish to grow to the size of companies like Wal-Mart or Macy's, but which are designed to operate on a smaller scale.

Subsidiaries

Members of LLCs can be corporations in addition to individuals. Corporations can find it beneficial to form an LLC as a subsidiary to section off a component of their operations. Corporations looking to gain an extra layer of liability protection and managerial control over specific departments can look to LLCs for the solution. The personal investment advisory service arm of a retail bank, for example, could be a good candidate for a separate LLC with the bank as a member, due to the high risk of liability issues.

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What Is a Disadvantage of the Corporate Form of Business Entity?
 

References

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