Corporations vs LLCs
LLCs are limited liability companies, legal entities used to form a business, offering protection from incurring personal liability for debts and other business obligations. Your personal assets can’t be used in legal disputes against the LLC.
LLCs are common as they provide a similar legal framework to corporations with fewer regulatory requirements. LLCs protect personal liability, preventing creditors from going after the owner’s assets. An LLC also allows taxation to be passed through, meaning business gains and losses are recorded/taxed on the owner’s personal tax return.
An S-corporation also protects you from corporate liability and passes through income (in the form of dividends) to avoid double tax due to personal and corporate taxes. S-corporations help companies establish more credibility with more oversight, as they must have a board of directors. S-corps can have up to 100 shareholders and pay cash payments from their profits or dividends.
S-corporations offer corporations with less than 100 shareholders to be taxed like a partnership. In some cases, you can form an LLC and choose to be taxed like an S-corp. To qualify, a business needs to meet specific Internal Revenue Service (IRS) guidelines.
Your chosen structure will significantly impact your business life, including exposure to liability, business taxes, and more. There will also be an impact on shareholders and the way you run the business.
Limited Liability Company (LLC)
LLCs ringfence your personal assets from losses, company debts, or court rulings. LLCs are popular for simplicity and liability protection, and they’re typically used by a single owner (sole proprietors) or a company with two or more owners (partners). LLCs also provide some benefits since they’re taxed differently from a C-corporation (also known as a traditional corporation). An LLC can be used for a company of any size, and you’ll see them used for family businesses, dentist’s offices, etc. There are a few things to learn about LLCs.
An LLC can have unlimited owners, commonly known as ”members”. Owners of an LLC don’t need to be U.S citizens or residents. Another corporate entity may also own LLCs.
LLC Business Operations
LLCs are a simple business structure; they have few mandates to follow, and while they may be urged to follow S-corp guidelines, they’re not required to do so. Some examples include adopting bylaws and conducting annual meetings. Instead of the detailed requirements for corporate bylaws, LLCs adopt an operating agreement. LLCs aren’t required to keep extensive records like an S-corp.
Limited liability companies are taxed differently. An LLC allows pass-through taxation, which occurs when the business income (or losses) ”pass through” the business and are recorded on the owner’s personal tax return, resulting in an income tax rate that may be more favorable. A single-member LLC is usually taxed as a sole proprietorship; any profits or losses are reported on the owner’s tax return. A multi-owner LLC works similarly, but it’s taxed as a partnership, requiring each owner to report profit and losses on their personal tax returns. LLCs avoid double taxation, which is a significant downside for some corporations.
LLC Pros and Cons
Let’s take a look at the distinct advantages and disadvantages associated with operating an LLC.
As mentioned, an LLC gives you limited liability, protecting your personal assets from liability. In addition, LLCs are easier to establish and operate and may be more cost-effective for tax purposes, LLCs are taxed once, but many corporations will be taxed twice. LLCs may also be cheaper to set up; corporations require appointed directors, officers, and board meetings, in addition to following rules that don’t apply to LLCs.
LLCs offer enhanced limited liability protections and offer simplified taxes, more akin to self-employment taxes, as you’ll only need to file your usual income tax return. More complicated types of business structures may require professional assistance or be liable for federal income tax.
LLCs also offer high flexibility, there are no limits to members or LLC owners, and LLCs can operate with one owner or several.
LLCs are at a few disadvantages, too. One of the key disadvantages is that it’s not as easy to raise capital; if they’ve been turned down for a bank loan, it could be hard to attract outside investment, but a corporation can usually raise cash from venture capitalist firms (providing a cash injection in exchange for a share of profits). LLCs don’t offer this benefit.
An S-corporation protects an owner’s personal assets from business liability and provides income in the form of dividends to avoid double corporate/personal taxation. Here are some things to consider about S corporations:
Owning an S-corp
The IRS can be restrictive towards S-corporations; these business structures can’t include more than 100 principal shareholders or owners. S-corporations can’t be owned under any other corporate entity. They can’t be owned by overseas individuals, non-US citizens, or permanent residents.
S-Corporations are more rigidly structured than LLCs. You’ll need to follow rigorous internal formalities, including strictly regulated corporate bylaws, annual shareholder meetings, meeting minutes, and extensive stock share regulations. S-Corporations are also required to use specific financial practices.
Management Structure of S-Corporations
S-corporations have more management restrictions, too. You’re required to provide a board of directors and corporate officers; the board of directors oversees the management and is in charge of major corporate decisions, while corporate officers (including the CEO and CFO) manage the company’s everyday operations.
The S-corporation’s existence (once established) can be perpetual, and LLCs are more easily dissolved.
S-Corporation Taxation and Fees
S-corporate income tax can ‘‘pass through’’ for federal tax purposes, and the shareholders of the S-corporation report the flow-through of income and losses on their tax returns, resulting in the assessed tax being calculated based on their tax rates. This feature helps S-corporations avoid double taxation (when the company’s income is taxed at the corporate level and dividend income is taxed again). You should consult state law, though. This matter is not always clear as each state has its own tax law pertaining to S-corporations.
S-Corporations Pros and Cons
Some of the key advantages and disadvantages include:
An S-corporation won’t typically pay federal corporate taxes. As a result, you can save money on corporate taxes more than a C-corporation. The S-corporation is a bit more complex but functions more like an LLC than other corporation types. An established S-corporation helps boost credibility with investors, customers, and suppliers.
S-corporations provide personal liability protection, preventing creditors from using personal assets to satisfy business debts. Employees of an S-corp are also members, which makes them eligible to receive cash payments as dividends from the company’s profits. Dividends are a great incentive for employees and can help you attract talented, motivated workers.
But there are some disadvantages, too:
Although many states allow income generated via an S-corporation to be taxed on the owner’s tax returns, some don’t, which means you’ll pay taxes twice. You need to check with your local Secretary of State office to determine how S-corporations are taxed in your state.
S-corporations incur several fees, including filing fees, registered agent fees, and other fees for the articles of incorporation (filed with your local secretary of state). They can also be cumbersome to start and manage, requiring extensive record keeping, a board of directors, and corporate officers.
Which Structure Is Best for You?
An S-corporation can begin as an LLC, LLP (limited liability partnership), or sole proprietorship and elect to become an S-corporation for tax purposes. An LLC is usually the easiest and most cost-effective to incorporate and offers the best protection for small business owners, partners, and proprietors. A business owner looking for the most substantial personal asset protection should consider an LLC.
But if you want to obtain substantial outside investment or eventually publicly trade and sell common stock, you might want to consider corporate options. It’s important to understand that S-corporations have chosen to be taxed according to Subchapter S of Chapter 1 of the IRS Service Code.
Choosing the correct business structure will depend on your organization’s size, aim, and scope, plus the number of employees, desired tax structure, level of investment, and tax considerations. More complex business structures allow for greater tax minimization; they can be more expensive to maintain and will usually require more assistance from professionals such as lawyers and accountants.
You may incur a tax penalty or other financial loss if you try to change the structure of your business, so you should carefully consider the most appropriate business entity when you first establish your business.