How to Choose What Business to Form: LLC vs Other Entities

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Everyone loves a good bracket.

Around March, our attentions turn to the NCAA tournament, and we get that bracket fever. We furiously fill in brackets advancing school’s we’ve never heard of, and we hope for the immortal glory that comes with getting every answer right.

That’s why I was not surprised to learn that people compare entities in bracket form. In fact, I’ve gotten this question so much now, that I’ve decided the time has come to write the definitive guide. March has its madness, and now, we will finally have the definitive answer to the LLC vs question…let’s call it The Battle Royale: LLC vs Other Entities.

This is Part 1 of a 3 part series. Parts 2 and 3 will be posted here as well.

Part 1 | Part 2 | Part 3

What is an LLC?

Before we get started with the battle royale, it would behoove us to examine what an LLC is. Succinctly, it is a Limited Liability Company. Don’t say Limited Liability Corporation. That’s not what it is. (Sorry, pet peeve of mine…moving on.)

An LLC is a relatively new concept (first adopted in 1977 Wyoming) meant to give you as the owner (in this case, a member) all the benefits of a pass-through entity, like a partnership, with the added liability protection of a corporation. But that’s not all! The LLC also allows you to elect different tax treatments with the IRS. This flexibility makes it ideal for companies in various stages of growth.

As a response to the restraints given by the S-Corporation and the Limited Liability Partnership, the LLC has been extremely successful. In fact, it’s become the preferred entity structure of many attorneys and business owners alike, but I get ahead of myself…

The Battle Royale: LLC vs Other Entities

How do these things usually start? That’s right! A play-in game. So, we will pit the upstart LLC against the oldest powerhouse known to man — the Sole Proprietorship. Without further ado:

LLC vs Sole Proprietorship

The Sole Proprietorship is the oldest entity structure known to man (and woman). The idea here is that Jane Doe has an idea for a business. She has no money. She has no assets. She just has an idea. So, she works and works and works to put the idea into motion. It works. She starts getting customers/clients. She starts hiring employees. She buys a store front. Just like the caveman selling cave paintings in prehistoric France, Jane has become the owner of a successful business. Without ever going to the Secretary of State, and without setting up any  structure, Jane is the proud owner of a Sole Proprietorship.

Bonus! Sole Proprietorship vs Partnership

If Jane ever adds another owner to her business, she would then own part of a partnership. That’s really all a partnership is, a sole proprietorship with more than one owner. It has some added elements to it (like a Partnership Agreement, for instance), but at its core, it joins the Sole Proprietorship as a disregarded entity (which means that the money earned passes straight from the entity to the business owner).

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The LLC is the grandchild of the Sole Proprietorship.

You see, there’s a problem here. Jane may not see it yet, but as soon as someone slips on the floor of her newly minted shop, she will find out quickly. The Sole Proprietorship offers no liability protection! Quickly, lawmakers went to fix this, and they came up with the Limited Liability Partnership that we mentioned above. The LLP didn’t provide the kind of flexibility that they were looking for, and so, on that fateful morning in 1977, Wyoming lawmakers went one step further, creating the LLC.

The LLC can be treated as a sole proprietorship for tax purposes (in a single member LLC), and it provides the added liability protection of a corporation without the formalities that corporations require. Seems like a Goldilocks perfect fit scenario, doesn’t it? Certainly it provides more security and protection than a Sole Proprietorship, but let’s compare it to some other entity types before we make our final decision.

LLC vs S-Corporation

This distinction is where a ton of solo entrepreneurs get confused. I’ve had so many people ask me if they should have an LLC or an S-Corporation. If I’m in an antagonistic mood, I sometimes reply with this gif:

LLC vs S-Corp

LLC’s and S-Corporations are two of the closest entity types you can get. They offer many of the same benefits with regard to liability protection and tax benefits. Still, an S-Corp and an LLC have some important differences, which means that you need to consider all sides before deciding. So, in an effort to get you pointed in the right direction, let’s start by looking at the benefits of an LLC over an S-Corp.

The S-Corp requires the owner(s) (which are stockholders, not members) to keep up with “corporate formalities,” and there are restrictions on the types of people/entities who can be stockholders. An LLC doesn’t require any of that, and as I mentioned above, it still gives you the two BIG wins an S-Corp offers — (1) a preferential tax treatment and (2) liability protection.

So, why would you choose anything different than an LLC? Well, there are some practical reasons. Some states charge more to file for an LLC than they do for an S-Corp. Additionally, some states require an LLC to have a dissolution date (a date when the company MUST end) whereas S-Corps can have a perpetual existence. Finally, ownership interest in an LLC may be more difficult to transfer since it would likely involve either a unanimous vote or majority vote of the members to initiate the transfer.

Should you choose an S-Corp or an LLC? It depends! (Don’t you love it when attorneys and accountants give you such definitive answers???) Truly this choice is a factual determination that you will want to make with your accountant and/or attorney.

Next time, we delve into the world of the C-Corp. See you then!

 

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