You may have noticed that there are an increasing number of businesses with LLC at the end of their name instead of “Inc.” or “Corp.” As the title of this article gives away, I encourage the use of LLCs over corporations. Some accountants and CPAs prefer corporations for some business types or certain owner types because of certain unique attributes afforded to corporations under the Internal Revenue Code (Tax Laws).
I agree with my team members that in some instances reporting to the IRS as a corporation is the most advantageous for the client, however, I still strongly recommend using LLCs instead of corporations. Let me explain my reasoning.
My primary reason
Corporations and LLCs are developed under state laws, which tell us how a corporation or LLC works, how its owners are protected and how they have to operate. In Texas, most of these rules are included in the Texas Business Organizations Code. For state purposes, if you own stock in a corporation, as a shareholder you are not liable for the claims against the corporation. This is the same result if you are an owner (member) of an LLC. Essentially, in both cases, the owner is protected from the business. This provides great protection for owners of businesses and one of the primary reasons for creating a business entity.
On the flip side, things start to take a different turn when we see how the business is protected from its owner. If the owner of a corporation is sued and a judgement is rendered against them, the person who won the law suit can take the shares of a corporation (yours or any you invest in the stock market) by executing the judgement. This could be a disastrous result, if your business is built to run itself, or if management can be hired to run it without you. Let me be clear by taking your stock, they can control the management and operations of your corporation. That is a situation no business wants to be in. The owner of an LLC has a different result.
The execution of a judgment against an LLC interest, is a Charging Order. The Charging Order is an order from the court in which the judgment says that if the LLC makes a distribution to the owner those payments need to be made to the person who won the lawsuit. They cannot become an owner or manager of your LLC. You are still in control and are not required to make distributions. This puts you in a strong negotiation position in the event of a lawsuit. This is one of the main reasons I prefer the LLC to the corporation in almost every circumstance.
What about the taxes?
So we see that for state law purposes, the LLC is preferable over the corporation, but what if the tax characteristics of the corporation make it worth taking this risk? Let me first clarify that Federal Tax Law, refers to the way a business organization will report and pay taxes. An LLC has a distinct advantage over the corporation, because it can make an election to be treated in a variety of ways under Federal Tax Law. An LLC can use form 8832 Entity Classification Election, and choose to be treated as a partnership, corporation or in some circumstances disregarded as an entity for federal tax purposes. This means that an LLC can be a corporation for tax purposes when it is preferable to report as a corporation. Effectively giving you the preferred protection of an LLC, and the income tax position that is most advantageous, giving you the best of both worlds.
In summary, the LLC provides better asset protection while also providing tax reporting flexibility. In my opinion this makes the LLC the preferred option in most circumstances.
If you are interested in forming a new entity or to review your business, contact me at 956-791-5422 or email at email@example.com to schedule an appointment for a review of your business structure.