Are you an entrepreneur who is trying to decide between setting up a Limited Liability Corporation (LLC) or an S Corporation? Understanding the differences between the two types of corporations can be a daunting task. In this blog, we will take a closer look at the basics of each type of corporation to help you determine which is the best fit for your business.
What is a Limited Liability Corporation (LLC)?
A Limited Liability Corporation (LLC) is a type of business structure that provides limited personal liability protection to its owners and combines the characteristics of both a corporation and a partnership. An LLC is formed by filing paperwork with the state, and it may be owned by one or multiple members. LLCs provide protection from creditors and legal actions and allow for the flow-through of income and losses to members.
An LLC is a great choice for businesses that want to take advantage of the flexibility offered by a corporate structure without the strict regulations and formalities associated with it. LLCs are easy to set up and maintain, providing owners with a simple solution to limit their liability while still having the ability to transfer ownership. Furthermore, an LLC can help protect business owners from any potential lawsuits that might arise from their business activities, as the company’s assets will be kept separate from the members’ personal assets.
What is an S Corporation?
An S Corporation (or S Corp) is a type of business structure that provides the limited liability benefits of a corporation with the pass-through taxation of a partnership. It is an entity distinct from its owners and it provides personal liability protection to its owners, protecting them from the debts and obligations of the corporation. Additionally, an S Corporation pays no federal income tax, allowing all of its profits and losses to be passed through to its owners and reported on their individual tax returns.
S Corporations are advantageous for businesses because they provide the same limited liability protection that a traditional corporation offers but without the double taxation associated with a C Corporation. Additionally, S Corporations may be eligible for certain tax deductions that are not available to LLCs. Furthermore, S Corporations can offer greater flexibility in terms of reinvesting in the business, making them a more attractive option for businesses looking to reinvest their profits into the business rather than paying out distributions.
Key Differences Between LLCs and S Corps
While LLCs and S Corporations both offer limited liability protection to their owners, there are some key differences between the two that should be considered when selecting a business entity.
As an S Corporation, actively participating shareholders are required to be paid a salary with payroll taxes deducted. While LLC members are paid as owner draws. LLC members can be paid a salary once the LLC has hired its first employee. This first employee cannot be an LLC member.
Another key difference between LLCs and S Corporations is ownership. With an LLC, there is no limit to the number of owners it can have, and owners can include individuals, trusts, estates, corporations, or any other legal entity. However, an S Corporation is limited to 100 shareholders and only individuals can serve as shareholders. An exception to the shareholder rule is a qualified subchapter S subsidiary, however, this exception is out of the scope of this article.
Finally, it’s important to note that S Corporations are subject to certain restrictions that LLCs are not. For example, S Corporations are required to hold regular shareholder meetings and keep the minutes of such meetings.
While LLCs and S Corporations share similarities, they also have important differences in terms of taxation, ownership structure, and restrictions. It’s important to consider these differences carefully when selecting a business entity in order to choose the right one for your particular needs.
When to Form an LLC
If you are starting a business, forming a Limited Liability Corporation (LLC) might be the right choice for you. LLCs are beneficial for smaller businesses because they are relatively easy to set up and maintain. LLCs offer personal liability protection to their members, meaning that members will not be personally liable for any debts or liabilities of the LLC.
LLCs also offer flexibility in terms of management; they can be managed by one person, multiple people, or an appointed manager.
Secondly, LLCs are not subject to some of the same regulatory and administrative obligations of other kinds of corporations, which means they’re appealing to entrepreneurs who want to minimize paperwork and the associated fees. A final point to keep in mind is that the majority of LLCs are less expensive than other types of legal structures for getting a business started, which may make them a suitable option for you.
When to Form an S Corp
An S Corporation may be the ideal choice for a business that has shareholders who want to avoid double taxation and who want more flexibility in how profits are distributed. This type of corporation is also beneficial for businesses that want to limit their liability since the owners of an S Corp will not be personally responsible for any debts or liabilities incurred by the company.
S Corporations provide tax advantages that an LLC does not. Self-employment taxes can be limited as long as a reasonable wage is paid to actively participating shareholders.
Let Market and Margin lead the way!
There are several different legal entities that you can choose from for your business, which makes selecting the right one a stressful and confusing task. Understanding the differences between each type of entity will help you make an informed decision. With Market and Margin’s team on your side, you’ll be able to identify the right structure for your business after understanding your options.
At Market and Margin, we have years of experience helping entrepreneurs make the right choice between starting a Limited Liability Corporation and an S Corporation. As experts in tax, business and financial consulting, we can provide you with a thorough assessment of both business types to see what works best for your specific situation.