CHOOSING BETWEEN AN LLC AND AN “S” CORPORATION WHICH IS RIGHT FOR YOU?
So you are starting your own business, Congratulations! One of your first decisions will be to choose the structure under which your business will operate. You’ve narrowed your choices down to an LLC (Limited Liability Company) and an “S” Corporation. How do they compare?
Personal Liability for Company Debts Both owners of an LLC, called members, and owners of an “S” Corp, called shareholders have limited liability. Generally, they are not personally liable for the debts of the company. Exceptions arise when corporate formalities are not followed or if an individual personally guarantees the debt of the company.
Formation LLC’s are easier to form. To form an LLC, one must file Articles of Organization and pay a filing fee to the Indiana Secretary of State. While not required, it is a good idea for LLC members to enter into an Operating Agreement. An Operating Agreement sets out, among other things, how the LLC will be managed and how a member interest may be transferred.
To form an “S” Corp, you must file Articles of Incorporation and pay a filing fee to the Indiana Secretary of State. Bylaws, containing provisions for managing the business and regulating the affairs of the corporation must also be adopted.
Administrative Formalities “S” Corporations are required to have a formal annual meeting and have record-keeping requirements that LLC’s do not. An “S” Corporation must issue shares of stock as evidence of ownership. LLC’s do not issue stock.
Distributions of Profits and Losses With an LLC there may be different classes of membership. LLC members may split profit and loss in any way they choose (provided IRS guidelines are followed). “S” Corporation profit and loss may be allocated only in proportion to each shareholder’s interest in the business.
Eligible Owners There is no limit to the number and type of members who may own an LLC. For example, an individual or another company may be a member of an LLC. In comparison, “S” Corporations are limited to a total of 100 shareholders, all of whom must be individual United States citizens or permanent residents.
Management LLC’s can be managed by all members or a designated manager. “S” Corporations are managed by Directors and Officers.
Taxation Unlike a “C” Corporation where the entity is taxed on reported income or loss and the shareholder is taxed on dividends received, both LLC’s and “S” Corp’s provide “pass through” tax treatment; meaning that income or loss from the entity passes through to members/shareholders. There is no double tax.
LLC owners may pay more in self-employment taxes than “S” Corporations because 100% of LLC members’ earnings will be subject to tax, including profits. With an “S” Corporation, shareholders only pay self employment tax on income received as compensation for services, not on profits that pass through.
So which do you choose?
For the majority of small business owners, the simplicity and flexibility of an LLC makes it a better choice. However, as each business owners’ needs are different, it is best to consult with a small business lawyer and your tax advisor to determine the right choice for you.
