First, we can pretty much dismiss basic income tax considerations. By default, an LLC is not taxed as a separate entity but a corporation is taxed separately. However, there are ways to override the default tax treatments. An LLC may elect to be taxed as a separate entity by filing IRS Form 8832. Subject to certain limitations, a corporation can avoid separate taxation (i.e., can become an “S corporation”) by filing IRS Form 2553. (Please note, however, that once a company is in business, certain types of transactions can have different consequences for LLCs than for corporations. Accordingly, every company should consult with a tax advisor both up-front and on an ongoing basis.)
The following are the factors that, in my experience, are most likely to lead an entrepreneur to form a corporation rather than an LLC:
- An expectation that outside funding will be sought, especially from institutional investors. Venture capitalists, in particular, tend to invest only in corporations.
- A desire to offer tax-advantageous equity ownership interests to employees and independent contractors. This is more straightforward to accomplish with a corporation than with an LLC.
- Prospective customers may feel that a corporation is more substantial and more “real” than an LLC. This is a marketing and sales consideration.
The most significant disadvantage of a corporation is compliance-related overhead. There is a need to conduct annual shareholder meetings and regular board meetings and to prepare and file minutes for those meetings.
What I have seen among my clients: If none of the pro-corporation factors is present, the client will form an LLC to avoid the expense and effort associated with compliance-related tasks.
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This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact an attorney directly.