Q: I will likely be making an investment in a company soon, and I was wondering if there is a difference between a limited liability company (LLC) and a corporation as an equity investor?
A: Although both types of entities, corporation and limited liability company, provide liability protection for you as an investor (assuming you are not actively engage in the management or operations of the company) – that means the only thing at risk is your investment money – there are some differences between the two types of entities.
Unlike a corporation, in which your investment is usually represented entirely by some sort of stock, an investment in an LLC can have multiple components, depending on the form and structure of the deal. An investment in an LLC can essentially be broken down into two buckets: Economic and non-economic rights. Economic rights are the equivalent of financial benefits, like your rights to distributions and the return of your money, while non-economic rights are just about everything, like your rights to vote, obtain information about the company, etc. When making an investment in an LLC, you need to carefully review the terms of the offering, as well as the company’s operating agreement. The operating agreement is usually a document governing the relationship and affairs among the LLC’s members and the company itself. Of course, for more sophisticated transactions, an investment in the stock of a corporation (such as preferred stock) can also have these kinds of complications.
Even though the tax treatment of the sale or disposition of your interests in either an LLC or a corporation should be the same, there may be a distinction when it comes to dividends (or interim distributions, as they are called in an LLC). Persons who are residents of the State of New Hampshire must pay a 5 percent Interest and Dividends (I&D) tax on distributions or dividends. An exception to this I&D tax exists if the equity of an LLC is not freely transferable. An LLC equity interest is considered not freely transferable if it cannot be transferred without prior approval from the LLC owners or if transfer causes the LLC to be dissolved. For this specific reason, the LLC may have an advantage over the corporation for New Hampshire investors because you may be able to avoid the I&D tax. If the investment is intended to spin off cash during the term of the investment, as opposed to just being an investment with potential upside someday, then the distinction between an LLC and corporation can have a significant effect on your tax liability.
In summary, investments in corporations and LLCs can have many similarities, but the distinctions, although subtle at times, may tip the scales in favor of one investment form over another, especially when it comes to the NH I&D tax.