As you are starting a business, you are confronted with a question right out of the box: Should you set up your new company as a Limited Liability Company (LLC) or as a Corporation? Each have their own set of guidelines, benefits and drawbacks. In this blog, I briefly compare LLCs with S-corporations (S-Corp).
This can be confusing. Being an S-Corp is an elected tax status. It doesn’t matter if you create an LLC or a Corporation – you can then choose to have the IRS treat you as an S-Corp for tax purposes. An LLC can be the same as an S-Corp for tax purposes. In this blog, I am comparing (i) LLCs that don’t elect to be taxed as an S-Corp, with (ii) Corporations that do elect to be treated as an S-Corp for tax purposes. Comparing LLCs with a C-Corp is a different blog.
So how do you know if you should set your business up as an LLC or an S-Corporation? It is important to consult with an experienced business attorney, like those at George Law, (248) 470-4300, to help you choose the correct entity structure for your business.
Why set your business up as an LLC?
An LLC is not distinct business entity, as is a sole proprietor, partnership, or corporation. An S-Corp, though, is not a distinct business — it’s how you choose to have your C-Corp taxed.
But you can also choose to have your LLC taxed as an S-Corp, a C-Corp, or even a partnership – it’s your choice! Also, you create an LLC under state law; being an S-Corp is solely a matter of federal-tax law.
Setting your business up as an LLC protects you from liability, which protects your personal assets. If your company is an LLC (and you maintain “corporate formalities” – see a different blog for a description of corporate formalities), you are not personally liable for its debts and obligations. If a debt collector sues your LLC, the debt collector can only go after your company’s assets, not your personal assets.
What is this “double taxation” I hear about with an LLC?
First, a legalistic primer — the owners (equity holders) of an LLC are called “Members.” The owners of a corporation are called “Shareholders.”
Many investors choose to have their Corporation taxed an S-Corp because it is a tax status that allows Corporations to avoid being taxed twice on the same income. How does that happen? Well, visualize an LLC that is generating revenue. How is that income be taxed?
- First, the LLC must pay taxes on the income that it generates, but then
- its members also must pay taxes on the same income after the LLC distributes it to them.
The LLC pays taxes on it and then its members then pay taxes on the same income. That’s double taxation.
An S-Corp, though, is different. The tax code permits it to deduct the wages that it pays to its Shareholders from its taxable income as a business expense So, though Shareholders have to pay taxes on the amounts they receive from the S-Corp, unlike an LLC, the S-Corp does not have to pay taxes on the same income.
For some, this makes a bit enough difference to select an S-Corp.
What are some differences between an LLC and S-Corporation?
Other differences between an LLC and an S-Corp include
- An LLC can have as members as it wants, but S-corps are limited to 100 shareholders.
- An LLC can have non-U.S. citizens as members, but S-corps can’t have non-U.S. citizens as shareholders.
- An LLC can have subsidiaries, but S-corps aren’t allowed to set up any subsidiaries.
- LLCs can issue Units (not stock), and S-corps can issue stock
- LLC Members can be different “classes”, but S-Corp Shareholders are all the same class
LLCs and S-corps also are different in their management structure. You can choose to have the Members manage your LLC (similar to how partnerships are managed). Or you can designate a Manager to manage your LLC, in which case members are not involved in daily-business decisions and the LLC more closely resembles a Corporation.
Unlike an LLC, an S-Corp generally has directors and officers. A board-of-directors oversees corporate formalities and makes major decisions. The directors typically elect officers to manage daily-business operations.
Is an LLC or S-Corporation better for entrepreneurs?
It depends on you, your business style, and your goals. Creating an LLC is a good start, because it protects you from liability and provides you with tax write-offs. But as your business grows beyond the startup stage, switching to an S-Corp may make financial sense. As income from the LLC increases, so, too, does self-employment tax. What is best in your situation? You should consult with an experienced lawyer, like those at George Law (248) 470-4300, to discuss the alternatives.