The TTB, the Federal agency that regulates distilleries, does not particularly care what kind of company you have, but you should. Accordingly, for most new distilleries, especially smaller businesses, the LLC is preferred over the corporation. They are more flexible and easier to run and set up.
Corporations have a hierarchical, rigid structure of shareholders, directors, and officers. Drafting the governing documents can require a bit more legal work than an operating agreement for an LLC.
Running a corporation also requires more clerical work. Someone has to keep shareholder ledgers, call director elections, conduct director and shareholder meetings, draft and track corporate resolutions, and deal with other corporate formalities. These are tasks that can divert your attention from running your distillery. In larger companies, these levels of formality can be helpful by distributing clear decision-making power among different people, especially when there are managers or investors who have diverging interests. This can happen, for example, where some investors are interested in seeing a company grow rapidly so it can be sold off, while others may not want rapid growth and instead prefer to treat the distillery as a lifestyle business. But in smaller distilleries, there may only be one to four people who own and run the company, and oftentimes they are close friends or family. If they set themselves up as a corporation, the same handful of people will be shareholders, directors, and officers anyway. An operating agreement can allocate managerial authority among these people in a simpler, more efficient way.
Most distillery owners we work with have heard of the “c-corp” and the “s-corp,” and mistakenly believe that these are types of business entities they might use to run their distilleries. However, these terms are not types of business entities but are simply tax classifications. In other words, a company might be taxed as one or the other during its lifetime even though it is incorporated as a single type of business entity.
Without going into too much detail, suffice to say that a c-corp structure is generally undesirable for new distilleries. A company taxed as a c-corp is subject to “double taxation.” That is, the company pays taxes on its earnings, then the shareholders pay tax on the dividends they receive. It’s an inefficient arrangement, especially for owners. Two other tax classifications, partnerships and s-corps, are more common for craft distilleries. In both a partnership and an s-corp, the company does not pay income tax on its earnings. Although you should work with a CPA from day one to ensure you’re being taxed efficiently, many distilleries are best served by being taxed either as a partnership or s-corp. Often, your CPA will advise you to switch from being taxed as a partnership to being taxed as an s-corp when your distillery begins generating sufficient income. Although it may be somewhat more complex to file your tax return as an s-corp, that expense can be offset through tax savings.
The reason LLCs are often better for new distilleries is that they are tax chameleons. They can be taxed as partnerships, s-corps, or c-corps if you write your operating agreement correctly. Thus, in its early stages, your distillery can be treated like a partnership, then it can elect s-corp status after it gets off the ground (for up to three years after formation). If you want c-corp status for some reason, that’s possible too. By contrast, corporations must be taxed either as a c-corp or an s-corp, depending on how they are set up.
Although LLCs are more flexible from a tax standpoint, there are somewhat complex tax rules that govern which classification your LLC can select. Be sure to consult with an attorney and a CPA when setting up your company to ensure you comply with those rules.