LLCs v. Incs. :: How to Decide and How to Convert

The Limited Liability Company is finally a mature entity in the United States. While historically the entity has been here and there since the 70s, it wasn’t until 1996 that every state in the U.S. had accommodated the L.L.C.

While a toddler, many were skeptical of the LLC entity. Lawyers and accountants were unfamiliar with the new entity, and were hesitant to give advice when the entity had not been tested in law or in the practical world.

More than one decade after that mid-nineties milestone, however, the L.L.C. is alive and well, and has proven itself to be the entity of choice in America. Accountants, lawyers and the general public are now comfortable with the entity, and its treatment under tax regulations and liability jurisprudence has been tested and made clear.

Despite its overwhelming popularity, however, many are still confused about the differences between the LLC and the Inc. These differences, however, are crucial to your business. The incorrect choice in entity type may defeat the purposes of the entity entirely.

In the Construction Industry where liability exposure and risk are high, it’s important to understand your choices in entity types. This article discusses the differences between the LLC and the Inc., their pros and cons, and the ease of converting from one to the other.

LLC v. Inc.
Generally speaking, if you are a small to mid-sized company, you are likely to be better off as a Limited Liability Company (LLC) than a Corporation (Inc.).

A corporation is required by statute to have stockholders, officers and a board of directors. While the Inc. may have only one stock holder and one director, it must have two individual officers. This means a corporation with one stockholder must pull in a second and willing individual to trust as an officer.

Corporations are also required to keep certain corporate records, take votes on decisions, record their meetings through minutes and have annual meetings with its stockholders (even if there is only one).

While large organizations benefit from the structure of a corporation and require it to thrive, small companies fall fate to the structure.

In reality, a small business will have a difficult time meeting the formalities of a corporation, and as a consequence the corporation’s liability shield may potentially be pierced in the event of a dispute.

Prior to the introduction of the LLC, there was a void between sole proprietorships or partnerships and full-blown corporations. Small businesses were simply stuck with the corporation as an entity type, because the only alternatives were sole proprietorships and partnerships (both without liability protection).

A Limited Liability Company fills this gap completely. It does not have the same formalities of an Inc., but it offers its members the benefits of liability protection. The entity is seen by many as a blend between the partnership and the corporation, and from the perspective of a small business, an entity taking the best qualities of each.

The LLC offers the flexibility and informality of a partnership, but maintains the liability protection of the corporation. In the spirit of its accommodating nature, the LLC allows its members to elect how it will be taxed: either as a corporation or a partnership. It’s the absolute best of both worlds for a small business owner.

Taxing a LLC
After the LLC entity was introduced in the United States, the Internal Revenue Service did not create a special taxation classification for it. To the contrary, the Treasury Regulations Section 301.7701-3 was pieced together, offering guidance to the LLC organizers on the tax classification for their new company.

Generally speaking, the manner of classifying a LLC is entirely up to the members of the company, and the IRS is very flexible in how it will tax the LLC entity.

A single member LLC generally has the following choices:

  1. File Form 8832 to be taxed as a corporation f8832.pdf
  2. If qualified, file Form 2553 (f2553.pdf), Election by a Small Business Corporation (Under Section 1362 of the Internal Revenue Code) to be taxed as an S Corporation
  3. Be taxed (by default) as a disregarded entity (individual single member are taxed as sole proprietorships, business entity single member taxed as a division of the corp.)

Multi-Member LLCs have the following choices:

  1. File form 8832 to be taxed as a corporation f8832.pdf
  2. If qualified, file Form 2553 to be taxed as an S-Corporation f2553.pdf
  3. Be taxed (by default) as a partnership

In Louisiana and Washington, a husband and wife who are owners of an LLC and share in the profits of the LLC can file as a single member instead of a multi-member LLC. However, they may also file as a multi-member LLC. This is generally true for other community property states as well, including Arizona, California, Idaho, New Mexico, Nevada, Texas and Wisconsin).

Converting Your Business from an Inc. to a LLC
Converting from an Inc. to an LLC is simply and fairly inexpensive. It requires that you file a certificate of conversion with the Secretary of State’s office, along with the LLC’s Articles of Organization and its Initial Report.

You must also notify the IRS that the company has converted to the LLC entity. This is important, as you’ll make your tax classification election at this time. As above-mentioned, your options for tax treatment are varied, and it will depend greatly on the practical needs of your business. You should review these options with your attorney and CPA.

Your Tax ID Number should stay the same, and if you choose, you can even have your tax classification remain unchanged.

Whether or not it is the correct entity type for your company, if your organization formed between 5 and 10 years ago, it’s likely that you formed as a Corporation.

The LLC entity is a safe alternative, and it may be the right entity type for your company.

Related Articles:
The Limits of Liability: Piercing the Corporate Veil

A Cure for Construction Litigation: Proactive Thinking Before You Get Started

Litigation is a frightening word to many yet to others it is seemingly unknown. The world of construction litigation has become massively entwined with confusion as to goals, limits, and the expectations of a litigant. Attorneys are often unable to properly advise a potential client as to the presumed costs and lengths of a legal proceeding simply because there is absolutely no way of knowing.

A legal proceeding depends upon several factors: the types of parties, the extent of the damage; the willingness to settle; the ability to settle; the requirements of outside contracts; the delays which may ensue; the ability to afford to legal representation; and unfortunately personal feelings towards another party. Though attorneys try, it is impossible to predict the extent of the variables and where and how the cookie may crumble. In the end, it is all an unknown.

Because parties are unable to predict the other side’s wherewithal to go the distance with a proceeding or arbitration, several dangers bear notice. Is it worth the risk to lose your financing? Is it worth the possibility of losing a good customer? Is it worth the costs of obtaining adequate legal assistance? These are the questions a headstrong business owner should be asking. Whether it be prior to contracting with another party, prior to beginning the work, or immediately after dispute arises, it is important to have a dispute resolution process or plan in mind for each job, contractor, or customer.

The dangers associated with contracting fallout can be prevented in a number of ways by being up front in your contracts with customers, contractors, and others. A good attorney can provide you with options as to strategies to use for dispute resolution. These strategies may encompass the whole project or merely deal with specific aspects. For instance, it may be wise for you to force immediate mediation of change orders or altered job conditions for price resolution, however you may want to utilize binding arbitration or even court intervention for disputes arising out of final payment. These mechanisms should be addressed during the contracting period, and every detail down to the venue, choice of law and choice of neutral should be decided by the parties.

Most people forget the contracting is open to the parties. It seems obvious that most contractors believe that there are only certain things that can go in a contract. Remember, the law of contracts appeals to your creativity. The more creative and forward thinking a party is, the more likely the contractor will have its way when dispute rears its ugly head.

Wolfe Law Group intends to release a series of Contracting Toolkits for construction companies. It is our hope that the Toolkits will spark some conversation amongst your company and your employees as to some of the problems you may face or have faced in the past. The Toolkits will provide a vast assortment of issues that face many contractors today, and the remedies that may save your firm endless time and money.

Whether you are in mold remediation and require extensive environmental obligations; whether you work in asbestos and need proper disclosures and releases; whether you lease heavy machinery to subcontractors and need warranty and release language; whether you provide fire damage services and need safety disclosures; or whether you simply need to ensure specific insurance compliance, Wolfe Law Group’s Toolkits can help you find a way to manage your needs.

Please stay tuned for more information. In the meantime, begin to think about what could make your construction process is run smoother.