Legal Question in Business Law in California

Re: LLC or C or S Corporation?

The LLC concept is still relatively new, and I think the legal and accounting professions are still figuring out the complete list of advantages and disadvantages.

One LLC advantage is that a member's loans or loan guarantees to or on behalf of the business can (often, maybe not always) be included in the member's "at risk" investment for calculating the maximum loss the member can write off. This is not generally the case with S corporations, so a business that expects to borrow (and the borrowing is from, or guaranteed by, the members) may benefit from being an LLC rather than an S corporation. This applies to many farming and real-estate oriented businesses that use lots of debt. It could also apply to high-tech and other startups that expect to lose money for a few years while they are in an R&D phase prior to having a markertable product. On the other hand, most such businesses can't borrow, and they rely on stock sales and option grants, concepts which are largely incompatible with the LLC concept.

This leads to the next principle. If you expect to sell equity, through an IPO or private placement, being a corporation makes things a lot simpler.

The LLC-vs.-corporation decision is more fundamental than the S-vs.-C decision. The former defines the nature of the beast. The latter is merely an election of how to be taxed. Sure, you can't toggle back and forth between S and C at will, but under certain circumstances and with certain consequences you can change your election......and often in the course of a company's growth that becomes desirable. However, switching between corporation and LLC is more like dissolving the business, selling the assets and starting all over. It can be doen, but it's radical surgery.

The self-employment tax rate is, I believe, exactly equal to the sum of the employer's share and the employee's share of the social security tax for a non-self-employed person. The government ends up taking the same amount. So, other things being equal, this should not be a consideration in the choice of organization.

It is, as you suggest, pretty much about running the numbers. Be sure you have the right tax rates and that your income projections are realistic. It is especially important to consider how you plan to finance the business and how its form of organization affects the availability of that financing.

At some stage of planning, you should involve professionals -- legal and accounting -- in your planning process.

Re: LLC or C or S Corporation?

One major advantage of an LLC over a corporation is the treatment of appreciated property upon the death of one of the owners. Generally, when you die, your basis in property is "stepped up" to the value of the property as of the date of your death. Thus, if you bought a house twenty years ago for $150,000 that's worth $300,000 at your death, your estate's basis in the house is stepped up from $150,000 to $300,000. When your estate sells it for $300,000, no one pays any capital gains taxes on the difference between the $150,000 purchase price and the $300,000 sales price. If your company is going to own appreciating property, such as real property, then your company must be an LLC to take advantage of this. If your company is a corporation and the corporation buys real property, upon your death the corporation's basis in the real property is unchanged. Your basis in your stock in the company is stepped up, but that may be of little value to you. If your company was an LLC, then the basis of your proportional share of the LLC's real property is "stepped up" and your estate benefits. I almost always recommend that a company that will own appreciating property be an LLC rather than a corporation.