Dallin Jenson

Many people who are just starting a business or have had an LLC for some time lack direction on what to go next. This blog post will attempt to articulate which business entity is right for your situation.

First, let’s explain what an LLC is.

The most common type of business entity for startup companies are Limited Liability Companies, commonly referred to as LLCs. Likely most of the businesses you see when you drive on the freeway are LLCs, and usually they are not huge businesses.

LLCs provide their owners with limited liability and offer flexibility in management and tax treatment. An LLC also has a benefit in that members and managers of an LLC, under Utah law, owe the entity a duty of care and loyalty. Owing a duty of care and loyalty involves managing the LLC in good faith and with a reasonable level of care without conflicting interests.  

Just like shareholders of a corporation, all LLC owners, aka members, are protected from personal liability for business debts and claims. This means that if the LLC incurs debt or is sued, members’ personal assets are usually protected (except for matters of “piercing the corporate veil” which will be explained later in this article). An LLC can choose to be taxed as a pass-through entity, which means that the LLC does not pay any taxes at the entity level, but profits and losses pass through to the personal income of the members, or they can choose to be taxed as a corporation. LLCs also have the option to be member-managed, giving all members a say in the business operations, or they can appoint managers to be member-managed, who may or may not be members themselves.

Another benefit of an LLC is that establishing an LLC is relatively simple. The members must file a document called the “articles of organization” with the state government, including the LLC’s name, its purpose, the main office address, and the names of its members. Although not always legally required, it is then advisable for LLC members to adopt an operating agreement. This document can be extremely advantageous as it sets forth the LLC’s rules regarding the rights and responsibilities of the members, allocation of profits and losses, procedures for changing ownership, and dissolution of the LLC. This can be the most important document of organization for the LLC, as whatever is written the members and managers will be held accountable to.  

While members are protected from personal liability for business obligations in an LLC, this shield is not absolute. Under certain circumstances, courts can “pierce the corporate veil” if members fail to treat the LLC as a separate entity. Piercing the corporate veil refers to a legal decision to treat the rights or liabilities of a corporation as the rights or liabilities of its shareholders. Normally, corporations are treated as separate legal entities that protect shareholders from personal liability. However, under certain circumstances, courts can disregard the corporate entity to hold shareholders personally responsible for the corporation’s actions or debts. Courts generally look at several factors when deciding whether to pierce the corporate veil. These factors include undercapitalization, failure to adhere to corporate formalities, commingling of assets, fraudulent representation, siphoning of corporate funds, and Alter Ego Theory. However, it is rare for courts to pierce the corporate veil as governments generally want to encourage business, and making their members liable for debts of the company is usually deterring. But it is important to acknowledge that members and managers of an LLC should do their best to avoid using business assets for personal use, in any circumstance. Doing so could lead to future problems for you and your company.

The bottom line for LLCs: If you want liability protection, flexible management, and the option to pick the tax structure that best fits your goals, an LLC is almost always the best decision. Just be sure to treat the company as a separate entity. Keep good records, avoid mixing personal and business funds, and follow your operating agreement. Choose a different structure only if you have very specific financing, tax, or governance needs that an LLC cannot meet.

Moving on from LLCs, let’s discuss corporations. A corporation is a state-created legal “person” separate from its owners, also known as shareholders. Corporations are formed by filing articles of incorporation within your state.  

The structure of a corporation shields shareholders’ personal assets from corporate debts, allows for survival through changes in ownership or management, and allows for raising capital by issuing transferable shares. Corporate governance and its structure is layered: shareholders elect a board of directors to set strategy, hire and supervise officers, and ensure legal and ethical compliance, while officers such as the CEO, CFO, and COO run day-to-day operations and implement board policy. Corporations face heavy reporting and record-keeping duties, especially if publicly traded, and reward shareholders with voting power on major decisions, dividend rights, and the ability to sue for wrongful acts. Corporations also have stock options. “Common stock” carries voting rights and last-in-line liquidation claims, whereas “preferred stock” usually does not include votes but enjoys priority dividends and asset distribution.

So, what are S-Corps?

There is no blanket-example to describe S-Corps such as large tech companies or chain restaurants. S-Corps elect to be taxed under Subchapter S of the Internal Revenue Code, meaning they keep the liability shield of a traditional corporation while allowing profits and losses to pass directly through to its shareholders’ personal tax returns instead of being taxed twice at both the corporate and individual levels. S-Corps can at maximum have 100 shareholders.

And C-Corps?

Again, C-Corps are corporations. C-Corps are the most common type of corporation, characterized by no limit on the number of shareholders, subject to corporate income tax, and legal separation from owners. S Corporations are similar to C Corporations but with restrictions on the number of shareholders.  

A C-Corp files its own tax return and pays corporate income tax before any money is distributed to owners. When owners later receive dividends, they are taxed again at the personal level. People call this “double taxation.” This structure is ideal for companies that expect to raise lots of outside capital, such as venture funding or public offerings, because it allows multiple classes of stock and an unlimited number of shareholders.  

Well-known examples of C-Corps include Apple, Microsoft, Walmart, and Costco, all of which benefit from the flexibility to issue different share classes and reinvest large sums of profit inside the company without passing that income through to owners each year.

In short, if your long-term aim is to attract large-scale investment, issue multiple classes of stock, or prepare for an eventual IPO (Initial public offering), the C-Corp structure offers the necessary flexibility despite double taxation. If, instead, you intend to keep ownership closely held, distribute most profits each year, and avoid double taxation while still enjoying the liability shield of a corporation, an S-Corp is likely the better fit.

The bottom line for all three types: Choose or maintain an LLC when you want the quickest setup, flexible rules, and one-layer taxes. LLCs are ideal for solos or small teams who just need a simple legal entity. An S-Corp is ideal when the company’s handful of U.S. owners work in the business, prefer pass-through income, and want to trim payroll taxes by taking part salary, part profit. Choose a C-Corp when you plan to raise lots of outside money, issue different stock classes, or go public.