Entrepreneurship has been called the new American dream. Hanging a shingle starts with an idea that develops into a business plan, but not without careful financial and legal considerations. Among the decisions that new business owners grapple with is whether to form a limited liability company (LLC) or an S corporation (S corp). There are similarities and differences between LLCs and S corps that business owners should understand before choosing between these two entities.
Similarities
- Both entities are created by filing the necessary paperwork with the state. Unlike a sole proprietorship or a general partnership, the LLC and S corp are not recognized under state law until the filing has been made.
- Both entities provide owners with limited liability, meaning your personal assets are protected from your business creditors’ claims.
- Assuming an LLC doesn’t make an election to be taxed as a corporation, both LLCs and S corps are pass-through tax entities, allowing business profits and losses to flow through and be reported on the owners’ personal tax returns.
Differences
- Unlike LLCs, which can have an unlimited number and type of owners, S corps are subject to strict ownership rules. S corps can have no more than 100 shareholders, may not have non-U.S. citizens as shareholders, and cannot be owned by corporations, LLCs, partnerships, or many types of trusts.
- S corps cannot issue classes of stock with different economic rights, while LLCs have flexibility in structuring the economic arrangement among its owners. However, an S corp can issue voting and non-voting classes of stock.
- S corps are subject to mandatory requirements as to how the entity is managed. For example, S corps are often required to adopt bylaws, issue stock, hold regular meetings, and maintain meeting minutes with corporate records. LLCs, on the other hand, are not subject to these types of requirements.
- Owners of S corps, unlike LLCs, may be able to reduce or eliminate the need to pay self-employment tax. An S corp owner can be treated as an employee and paid a reasonable salary. Employment taxes are withheld from the reasonable salary, while corporate earnings in excess of that salary may be distributed to the owners as unearned income, free of self-employment tax.
- S corp owners must share profits equally based on their percentage of ownership, while LLC owners have wide latitude to split profits and losses in any manner that is agreed upon.
- LLCs are generally cheaper to form and operate.
While the LLC is often the optimal vehicle for small businesses, each business has its own set of circumstance to consider. Don’t go it alone. We are here to discuss how to properly structure, form, and protect your business. Please give us a call to schedule a consultation today.
