LLC OR S-CORP — WHICH ONE IS BEST FOR MY BUSINESS?
LLC OR S-CORP — WHICH ONE IS BEST FOR MY BUSINESS?
So here you are – you turned right at that crossroads where you decided to start your own business OR you’ve been in business for years and now realize that you need to protect your family and personal assets as your business grows. Choosing the right entity for your business can be an overwhelming experience because there are a number of legal and practical aspects to consider with each entity. How much will I have to pay in taxes? My income is being eaten up by taxes; can I get a tax break with this entity? Is it expensive to incorporate my small business? What about state requirements? How do I address liability issues?
Do any of these questions sound familiar?
Frankly, business structures and the interplay between them can be confusing. For example, Limited Liability Corporations (“LLC”) and S Corporations (“S-Corp”) are separate entities. However, an LLC can be taxed as an S-Corp, C-Corp, or even as a Partnership. Given the complexities that arise from the tax-interchange of entities like LLCs, it’s important that you sit down with an experienced professional to guide you through this decision-making process.
If you are starting a new business or you are reconsidering a previously selected business structure, take a look at the information below. This information is a primer that lays out some of the essential characteristics of an LLC and S-Corp. Check back soon to learn about the major distinctions between other business structures you could form, like Partnerships, C Corporations and a Sole Proprietorship.
Key Similarities Between an LLC and S-Corp:
Limited Liability. Typically, both an LLC and S-Corp afford your personal assets protection from business. If the company is being sued, the claimants are suing the company, not you—the owner or investor. Furthermore, limited liability means you are not liable for debts beyond the amount you invested in the LLC or S-Corp. For instance, if you have invested $20,000 in your LLC and you have debts of $32,000, you are only on the hook the $20,000 you invested.
Avoid the “dreaded” Double Taxation. By and large, no income taxes are paid at the business level; business profits or losses are passed-through to the owner’s personal tax returns.
Key Differences Between an LLC and S Corp:
OWNERSHIP
LLC Ownership. LLCs are not restricted to a specific number of members (owners); S-Corps are limited to 100 shareholders.
S-Corp Ownership. Non-U.S. citizens/residents can be members of an LLC; S-Corp owners cannot be non-U.S. citizens/residents.
MANAGEMENT
LLC Management. LLC owners can choose to have members (owners) or managers run the LLC. When members manage it, the LLC operates like a partnership. When managers run the LLC, it operates more like a corporation because members are typically not involved in day-to-day company decisions.
S-Corp Management. Unlike LLCs, S-Corps have directors and officers. Directors oversee major company decisions (establishing a mission, approving budgets and creating policies/directives), while officers manage the daily operations and activities of the organization.
Pros and Cons of an LLC:
Pros
Less Expensive to Setup. Setting up an LLC typically costs a few hundred dollars compared to setting up some of the other business entities.
Tax Reporting. The owner of a single member LLC does not have to file a tax return for the LLC, and reports the LLC’s financials on their personal tax return.
Cons
Corporate Veil. LLC owners must exercise caution to avoid “piercing the corporate veil.” Simply put, a business owner can lose the protection that separates the LLC’s assets from their own personal assets. Grounds for piercing the corporate veil can include: the business owner’s failure to maintain separate identities, failure to capitalize the company, failure to follow corporate formalities (commingling of personal funds with business funds), or engaging in some form of fraud/wrong-doing.
Often, you see these types of cases when a claimant has sued a company that defaulted on a service or promise only to discover that the company they sued is bankrupted or out of business. This is when piercing the corporate veil becomes vitally important to the claimant who may be able to point to grounds that justify reaching into the deep pockets of the defunct-company’s owners. This level of investigation and justification is not something you want to tackle alone as a claimant.
Self-Employment Taxes. Because single member LLC owners are required to pay self-employment taxes on the company’s income, they are required to make quarterly estimated payments to the IRS. They may also need to make payments to their appropriate state tax agency when required by state law.
Pros and Cons of an S-Corp:
Pros
Tax Benefits. An S-Corp pays its employees a “reasonable salary” and, therefore, deducts payroll expenses like federal taxes and FICA. Remaining profits from the company can be distributed to owners as dividends that are taxed at a lower tax rate than income.
Cons
More Costs Involved. Forming an S-Corp can be more expensive. The more shareholders you have may increase the costs associated with needing a professional to prepare filings, forms and agreements. However, this should not deter you from considering an S-Corp as an ideal business entity because S-Corps can attract investors through the sale of stock. Plus, it has great tax benefits.
State Taxes. States may require additional state taxes for S-Corps. Check with your state’s tax agency or corporation division to determine your obligations.
Salary Standard. The IRS scrutinizes S-Corps more. Unlike an LLC, an S-Corp must pay its employees a “reasonable salary.” You should speak with your tax consultant or payroll specialist to calculate what a reasonable salary is for you and/or your employees based on your business’ financials.
Is Creating an LLC or S-Corp Right for You?
In classic lawyer-fashion, I’m going to answer this question with a few questions you should ask yourself and consider. Is a business entity that’s more simplistic to organize, setup and administer tax obligations attractive to you? Are you a new business owner? Perhaps the LLC is the best option for you.
Do you plan to bring on investors or share the ownership of the company with employees? Is your business growing and about to take on new opportunities and ventures? Maybe you should consider an S-Corp or another corporate structure.
When you’re standing at the crossroads of choosing the right business entity, these are critical questions to ask yourself and perhaps even think through with a professional.
Your thoughts: Which business entity is most appealing to you – LLC, S-Corp or another entity? If you’ve already organized your business structure, what benefits and advantages have you experienced? Feel free to add to our list in the comment section below.
This article is intended to provide you with general information; it does not constitute any type of legal advice. For recommendations related to your specific matter, we encourage you to review our Practice Areas page for additional information and then contact us to discuss your company’s legal needs.