Optimal Legal Structure: Corporation or LLC?

The answer to this question is relative to the structure purpose. If you are initiating a start-up, I agree a C may be preferable. Capital raising and ownership transfers are more complex with a LLC, as you deal with Partner approval. But the double taxation of a C makes you pause.

I give a nod to the corporate structure when there are plans to dribble out some junior equity to management / employees. Dole out a little % of LLC membership to Mary Manager, and suddenly she's a "partner" getting a K-1, with all the additional allocation complexities that entails (especially when it's a different class of equity).

And (I suppose, unless new regs have been issued to address the problem), Mary comes off of payroll, with her regular salary now deemed a "guaranteed payment", and facing the additional burden of figuring quarterly estimate payments. (As it's been a while since I looked at this particular issue I acknowledge that the IRS may indeed have addressed this matter in recent Regulations.)

Depends on the size of the company. For the majority of folks who will never raise capital, which is most small businesses...an LLC should work fine, unless they are in the type of business which would benefit from keeping all tax liabilities with the company rather than the owners...then a Corp would be best.

As stated previously, it depends. If you think your client will want to raise venture or private equity capital, they need to be C corporations; almost all venture capital or private equity funds have provisions prohibiting them from investing in portfolio companies that are LLCs because of tax complications with LLCs for investment funds. Also, almost all venture capital firms want management to be incentivized and aligned with shareholders via stock option plans. While it’s not impossible to implement the equivalent of a stock option plan in an LLC, it’s very difficult to do, primarily because LLCs have membership interests instead of stock, and it doesn’t have the same tax advantages.

Often, the need to raise institutional capital from third parties and the intent of having stock option plans outweigh the double taxation problems with a C corporation. One option that might work is to start off as an LLC and convert to a C corporation when appropriate. This may allow the tax losses as the business ramps up to flow through to the owner(s). Converting to a C corporation later isn't all that hard or expensive, but it isn't free, and it will impose a fair amount of administrative burdens on the company for a few months.

But the weight of the various factors varies in every situation, so there’s no substitute for knowing your customer’s plans and needs. And ultimately, it’s their decision.

If you intend to raise outside capital C-Corp is definitely the way to go as that is what most independent investors are going to require anyway. C-Corp also is much better if you intend to have some type of management ownership incentive. In most closely held C-Corps double taxation is usually manageable. S-Corp is also an option for a new C-Corp to avoid double taxation even if the intent is to later raise capital and intentionally revoke the S election.

If the company intends to stay private and closely held, LLC will generally offer more tax flexibility and some marginal savings on cheaper corporate governance.

I also have to add since it is a common misunderstanding, you don't really incorporate as an S-Corp. Your legal entity is either an LLC or C-Corp. S-Corp is a federal tax designation, yes I know some states have what they call an S-Corp, but unless you file with the IRS to have your entity elect S status you are not really an S-Corp.

Completely agree. Raising capital in Silicon Valley as an LLC, and then the complications of the subsequent conversion, were a pain: expensive and lengthy process. Next time, it's straight to C-corp.

Starting an LLC conversion to C-Corp to be ready to take investors. It's annoying- kind of like when your debits don't equal your credits.