US Corporate Entities: Why the LLC is the Clear Winner

12 Apr US Corporate Entities: Why the LLC is the Clear Winner

by Omar Hakim, Esq.

Introduction

We are often asked which corporate entity our overseas clients should use to start their US businesses.  The answer is almost always a Limited Liability Company (“LLC”).  This entity is the preferred choice of our President, Donald Trump, for good reason, and this is one of the few areas where we recommend our clients follow the President’s example.  Using a LLC provides numerous advantages over that of a limited partnership or a corporation,[1] the two other primary corporate entities available in the United States.  This article will discuss three key features of LLCs that make it the preferred entity structure for entrepreneurs looking to start a US business.

Avoiding Double Taxation

The first major advantage of using a LLC is that it avoids the double taxation that applies to corporations.  Corporations pay a corporate tax on profits and then the corporation’s owners pay a tax on the profits distributed to them.  Under LLCs and limited partnerships, there is generally no corporate tax on the LLC.  The owners of LLCs and limited partnerships simply pay taxes when profits are allocated to them and this is the only time that the profits generated by these entities are taxed.

Lack of Formalities and Recordkeeping Requirements

The second key advantage of using a LLC over a corporation is that the recordkeeping requirements are much simpler for LLCs.  Corporations have a board of directors and officers as opposed to a LLC which can be run by a manager.  The corporation must hold director meetings, as well as shareholder meetings, and must keep minutes of such meetings.  If a corporation fails to follow these strict formalities, it may lose its limited liability shield.  This would be a disastrous result as it would mean that the corporation’s owners could be personally liable for the corporation’s debts.  In such a scenario, if the corporation went bankrupt, its debtors could start placing liens on the stockholder’s assets.

On the other hand, with LLCs and limited partnerships, there is no such requirement to observe these formalities.  An LLC may choose to have such specific formalities in its operating agreement if it chooses to do so, but it is not required.  This flexibility gives the LLC a major advantage. If an overseas client is to be the sole owner of a new LLC in the United States, there is no need for any formalities at all: there is no benefit to requiring them to hold meetings with themselves. If the client is starting a business with a few business partners, then they may decide to implement some formalities for LLC to prevent abuses of power.  If there are dozens of members of the LLC investing as business partners, it would likely make sense to require more formalities so that documentation is available to provide all members with updates and give them a means to check abuses of power.  It is this flexibility and scalability that provides LLCs with a clear advantage over corporations.

Limited Liability

The third major advantage of using a LLC is that it provides limited liability for all of its members and its managers.  Thus far, we have primarily focused on the advantages of LLCs when compared to corporations.  With respect to the issues of double taxation and recordkeeping, the LLC emerges as a clear winner versus corporations, though it does not have a significant advantage over limited partnerships. With regard to limited liability, the LLC structure does not provide any substantial advantage vis-à-vis the corporation, provided the corporation follows its recordkeeping requirements, as discussed earlier. However, the LLC is a far superior mechanism for shielding the members and management for liability for the business’s debts and liabilities when compared with a limited partnership.  In a LLC, there are members who invest in the business and then there are managers who run the business (or managing-members who both invest in the business).  Neither the members or the managers are personally responsible for the debts and liabilities of the LLC, as long as they do not engage in wrongful or fraudulent conduct and do not use the LLC for personal expenses.

On the other hand, with limited partnerships there are limited partners and general partners.  Limited partners have limited liability but can only have minimal control over business decisions or operations, and normally cannot bind the partnership to business deals.  The general partners have the right and responsibility to manage the day-to-day operations of the limited partnership, but they have unlimited liability for the debts and liabilities of the limited partnership.  This means that if you start a business via a limited partnership and an accident occurs on your premises, then you may be personally responsible, if your business is sued for the injuries, or even death, caused to the victims.  If the business defaults on a loan or cannot pay its vendors, then you as a general partner may be held personally responsible for those debts.  Clearly, most people would like to avoid this result when starting a business which makes the LLC an obvious choice over the limited partnership.

Conclusion

As discussed in this article, the LLC combines the simplicity of the partnership with the limited liability of a corporation to make it the clear-cut choice for entrepreneurs looking to start a business in the United States.  This is why we advise our overseas clients to use them with rare exception.

[1] It should be noted that this article is discussing C-corporations and not S-corporations as S-corporations may not have non-U.S. citizens/residents as shareholders.  However, we still advise US residents to use LLCs rather than S-corporations due to less onerous record keeping requirements.

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