Each year hundreds of thousands of foreign businesses establish US operations. While entity choice may require consideration of corporations, Limited Liability Company’s (LLCs), Limited Liability Partnerships, Limited Partnerships, Professional Corporations and S Corporations, in our experience the two most relevant entity choices for foreign business are corporations and LLCs.
We often find that clients proceed with the establishment of an LLC because there is a perception that they are more cost effective and simpler to establish and manage than corporations. In many cases this is this not the case. Below we have summarized the differences between the two and why corporations can often be a superior choice for foreign business owners.
What is a LLC?
A LLC is an innovation of US law that is governed by state based legislation. It resulted because of the complex and expensive nature of partnership taxation in the US. Partnerships were costly to set up and administer and easy for taxpayers to abuse.
The government wanted to give all taxpayers access to flow through taxation and so LLCs were created and state legislators introduced laws to govern their existence.
LLCs are often referred to as a simpler than corporations from a corporate law perspective because the corporate formalities that govern US corporations do not apply to LLCs. Examples of the formalities are: the requirement to hold annual meetings; take minutes; and sign director resolutions.
The single biggest legal difference between LLCs and corporations is the different level of legal responsibility that a director has over a manager. A director of a corporation owes far more onerous fiduciary obligations to its shareholders than the manager of a LLC owes to its members.
How is a LLC taxed?
The default tax status of a LLC is as follows:
- for a LLC that has one member it is to be taxed as a disregarded entity (ie sole proprietorship); and
- for a LLC that has two members it is to be taxed as a partnership.
Disregarded entities and partnerships are taxed on a flow through basis. Alternatively, the owners of a LLC can elect for the LLC to be taxed as a corporation. This will result in the profit of the entity being taxed as corporate tax rates and to the extent that profit is distributed to the members, such profit being taxed as dividends.