Determining the type of legal structure for a new business can be overwhelming for entrepreneurs and small business owners. Unlike sole proprietorships and partnerships, corporations and limited liability companies (“LLCs”) are preferred business structures because both offer the owner liability protection. That means the owner of a company cannot be held personally responsible for the company’s debts. The personal assets of an owner are shielded from company liabilities.
Our law office can assist you in setting up two main corporate structures, the S Corporation and the LLC. Both are similar in that they are “pass-through” entities for tax purposes; the income of these companies is passed through to their owners and reported on the owners’ personal income tax returns, thereby eliminating the double taxation incurred by owners of a standard corporation, or C Corporation (with a C Corporation, the net business income is subject to corporate income tax, and the monies remaining after the corporate income tax are taxed a second time when they are distributed as dividends to its owners who must then pay personal income tax). For more information on the tax implications, click on the link to the right entitled “Tax Treatment of S Corporations and LLCs”.
So what is the difference between an S Corporation and an LLC? And which structure is right for you? The answer depends on your own unique situation. Click on the links below for more details:
- Personal Liability
- Restrictions on Ownership
- Corporate Formalities
- Profit Distribution
- Summary of Differences
S Corporations and Limited Liability Companies (“LLC”) both protect owners from personal liability for business debts and other liabilities, as long as all corporate formalities are followed.
Restrictions on Ownership
LLC members may be any person or organization while S Corporation shareholders must be individual U.S. citizens or U.S. residents, estates or certain trusts (they cannot be other corporations or LLCs). Also, the number of shareholders is limited for an S Corporation while an LLC may have an unlimited number of members.
An S Corporation is required to follow all corporate formalities (i.e., meetings, records, and minutes); an LLC has no similar required formalities and therefore offers greater ease of operation.
An S Corporation’s shareholders elect a Board of Directors which has overall management responsibility and officers of the company have the day-to-day responsibility to manage business activities; LLC members themselves may manage the business or they may appoint other managers.
S Corporations must distribute profits to shareholders based on capital contributions, even if the owners feel it is more equitable to distribute the profits differently; LLCs may decide how to structure distributions to members which offers greater flexibility in ownership.
As an example, let’s say that you and a partner own an LLC. Your partner contributed $75,000 in capital. You contributed $25,000 but you perform 90% of the work. If your business was set up as an LLC, the two of you could decide, in the interest of fairness, that you will split the profits evenly, each taking 50%. On the other hand, if the business was set up as an S Corporation, you would only be entitled to take 25% of the profits while your partner would take the other 75%. The shareholders in a corporation, however, could pay a salary or wage to the sweat equity shareholder in his or her capacity as an officer thereby compensating that shareholder for services rendered. That shareholder, though, will pay more in self-employment taxes with such an arrangement.
Summary Of Differences
|S CORPORATION||LIMITED LIABILITY COMPANY|
|Operational Control||Managed by board of directors and/or officers||May be managed by owner-members or managers|
|Federal Income Tax||Pass through||Pass through|
|Flexibility/Ease of Operation||Required to follow formalities||No corporate formalities|
|Flexibility in Profit Sharing||No||Yes|
|Employment Tax||Employment/payroll tax on salary; no employment tax on dividends paid to shareholders||Self-employment tax on total net income|