Not sure which business entity is best for your company? When starting a business, or growing a business from a sole proprietorship, the LLC and the S-Corp are two of the best entities for small business owners. Both entities provide liability protection (which prevents business creditors and those with a judgment against you from accessing your personal assets) and act as a pass through which means that all income from LLCs and S-Corps are treated as income of the individual owners. However, there are various differences between the LLC and S-Corp.
Instead of randomly choosing one or the other, here are some of the differences that may affect which one you choose for your business:
1. Corporate Formalities
LLCs generally do not have to maintain corporate requirements, even though its good practice to maintain separate company records. In some states, LLC owners are required to file a simple biennial statement with the Secretary of State but that’s about it. S-Corps, on the other hand, are required to maintain corporate formalities in order to keep their liability protection. S-Corps must keep meeting minutes, a board of directors, officers, separate business accounts and appropriate records for all of its business transactions.
2. Allocating Income
This issue only comes up when there are several owners of the business or when additional owners will be added in the future. LLC owners may allocate the business income to its member disproportionately. That means that two owners may split the income 60-40 instead of 50-50. This may be important in situations where each owner contributes to the business differently.
For example, where one owner is putting up startup capital and the other is putting in sweat equity. S-Corps do not have this flexibility. Owners of an S-Corp (also known as shareholders) are required to split the income equally among all of the owners.
3. Filing Taxes
LLCs with one owner do not have to file separate tax returns for the business. They can typically add a Schedule C to their personal taxes and be done with it. LLCs with more than one owner do have to file separate tax returns, but have the flexibility to file as a partnership or a corporation. S-Corps must file information returns every year and their owners have to add a Schedule E to their personal taxes.
4. Startup and Operation Costs
Maintaining corporate formalities and filing additional tax returns may increase the costs of running an S-Corp. However, in several states the filing fees to create an LLC are substantially more than the fees to create an S-Corp. In some states, such as New York, LLC owners are required to publish the name of the LLC in two newspapers which can easily cost well over $1,000. It’s important to be aware of the filing requirements and associated costs in your state.
5. Restrictions on Type of Owners
In most states, LLCs may be owned by individuals, corporations, other LLCs and foreign entities. S-Corps are not so flexible. S-Corp shareholders must be individuals (not partnerships or corporations) who are U.S. citizens or permanent residents. Additionally, an S- Corp can have a maximum of 100 shareholders. Certain types of businesses may not be LLCs or S-Corps including banks and insurance companies.
6. Public Perception
People who may be important to your business’ development can have strong opinions about the different business entities. I have heard from both bankers and venture capitalists that they are not fond of LLCs and prefer to invest in corporations. I also know lawyers who think the LLC is the best thing since sliced bread. I think that corporations, with all their formalities, can influence the way you treat your business and the level of professionalism that you maintain. Additionally, public perception of an LLC versus an S-Corp may be different. Incorporating may show customers, banks and other potential investors that you are serious about growing your business and that you intend to be around for a long time.
These are just some of the various factors to be considered when selecting a business entity. I highly recommend a consultation with both an accountant and a lawyer to determine which entity will fit your business best.
Disclaimer: This post discusses general legal issues, but it does not constitute legal advice in any respect. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction. YFS Magazine expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this post.