Is a LLC better than a corporation?

Someone who is starting a business asked me recently if they should form a LLC or a corporation and if either would be better in terms of formation costs.  There are a lot of things to think about when you are considering an LLC, but very generally speaking, it will not be the cheapest option. While a corporation has a formal structure (e.g., each corporation is generally required to have a board of directors, stockholders, annual meetings, etc.), an LLC is much more flexible. However, with that flexibility come added startup costs. Because a corporation's structure is dictated by state statute, you can establish a corporation by filing a form with your state's Secretary of State, establishing some bylaws, and you are up and running (structurally speaking).  A LLC, on the other hand, is a hybrid organization that state governments created to combine some of the liability features of a corporation with the tax benefits of a partnership.  While the first state to allow LLCs was Wyoming (!) in the late 1970s, most states did not recognize LLCs until the 1990s. Therefore, it is still a very new concept. Most state statutes intentionally provide a tremendous amount of flexibility with respect to how LLCs can operate; the terms are generally left up to the members of the LLC to determine by creating a contract called an "operating agreement" or "limited liability company agreement".

But do you need one? In Delaware, for example, the law was revised in 2007 to require a limited liability company agreement, whether written, oral, or implied. And while Massachusetts simliarly allows oral agreements, it also requires that certain matters be written into the company's records.

Which brings us to the costs. As with many legal issues, flexibility often leads to increased costs. A good operating agreement not only includes information on the rights of members, but also directs accountants how to deal with capital accounts and distributions, how to allocate profits and losses, and other tax provisions. The cost for creating an operating agreement varies widely. We often provide our clients with a flat fee structure for creating the operating agreement so that you can focus on getting it right, not just getting it quick. You should talk with your attorney about finding the most efficient route.

State filing fees can be a factor as well.  Filing fees in Massachusetts start at $275 for most corporations, while an LLC will cost you $500. However, you also have to renew the entity's status each year with an annual report that will cost you $125 (or $100 if filing online) for a corporation, while a LLC has to pay the same $500. And filing in another state (e.g., Delaware) will not allow you to avoid the Massachusetts fees if you are operating here. You will still have to register with the Massachusetts Secretary of State as a foreign LLC and pay similar filing fees.

Finally, you should consult with you tax advisor regarding the effects on you personally.  With a LLC, you may be subject to self-employment taxes which could have a dramatic impact on your decision, but that will depend in large part on your individual situation and structure.

In any event, remember to put these costs is perspective. While you may have to invest some money up front, the liability protection and tax benefits of a LLC will serve your company for years to come.  You can avoid some big headaches down the road with some simple but effective preparation up front.