Choosing a business entity can be confusing. If you’re debating between registering as a LLC or S Corp, we can help break down the pros and cons of each so that you can make an informed decision.
Keep in mind as you choose between a LLC or S Corp, what is going to be best for your business now, as well as in the future. You can always change your entity as your business grows, but it doesn’t hurt to look ahead.
What is an LLC?
According to the U.S. Small Business Administration, “A limited liability company (LLC) is a hybrid type of legal structure that provides the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership.”
An LLC separates a business from the business owner in terms of liability. In the event that they are sued or in debt, their personal assets (home, cars, investments) cannot be touched. Owners of a LLC are only liable for as much money as they put into the company. For example, if you invest $10,000 in your LLC then get into debt for $20,000, you’re only potentially liable for the $10,000.
Because the LLC is separate from the business owner, the owner cannot “pierce the corporate veil,” meaning that they can’t mix personal and business. If the lines become blurred the owner can loose his or her protection.
When you’re registered as a LLC, the federal government doesn’t tax your business directly. Instead, they tax your personal income (or the income of all members). You would still take any deductions on your business expenses, but you don’t have to file a separate tax return for your business. Some states may require LLCs to file separate tax returns, so make sure you learn about the laws for your state.
Although you aren’t submitting a separate tax return for your business, the IRS still requires you to pay estimated quarterly taxes for your LLC.
LLCs are relatively easy to set up. The paperwork is fairly minimal and it usually only costs a couple hundred dollars.
What is a S Corp?
An S Corporation (S Corp), is a type of corporation that meets specific IRS requirements. S Corps have the benefits of a corporation but are taxed as a partnership. In order to qualify as a S Corp, the business must have 100 or fewer shareholders.
Like a LLC, a S Corp separates business owners from the business. Creditors can only go after the business they can’t touch the business owner’s assets to pay any debts. Shareholders are also only held accountable for their investments in the company.
The taxation of a S Corp is what sets it apart from other business entities. When you have a S Corp, you don’t have to pay taxes on the business itself. Instead it is taxed through the income of the shareholders. Any shareholder who works for the must be paid a “reasonable wage.” A reasonable wage is usually fair market value for the position and size of the company. After the wages are paid, the rest of the income from the business is passed onto the shareholders as dividends. The benefit of an S Corp is that dividends are taxed at a vey low rate, if they are taxed at all.
The laws for S Corps are not the same in each state. Be prepared to pay taxes if that is what your state requires.
Getting a S Corp established takes a lot more than an LLC. Most S Corps spend a considerable amount in attorney and accounting fees. There is a lot of paperwork involved. You must also develop a board and bylaws, issue stock, hold board meetings and keep records of each board meeting.
The IRS also has the following requirements for S Corps
- Shareholders must be US citizens
- Cannot have more than 100 shareholders (spouses count as separate shareholders)
- Can only have one class of stock
Final decision: LLC or S Corp?
Deciding betweem a LLC or S Corp, it comes down to your business individually; there is no right answer.
That being said, you need to consider the pros and cons of both. LLCs and S Corps have limited liability protection, so you don’t have to weight that option. However, the tax benefits and set up requirements should be considered.
Before you make a big business decision like this, it’s best to involve your accountant and lawyer, they can help you determine what is best for your business.