Deciding a business structure, before starting any company, is the most basic and important step that everyone should follow. Most of us often get confused between an LLC and an S Corp. Both of these structures have various similarities yet have stark differences at the same time. The most appropriate way to find any business structure is to first make a structural plan, the suitable procedure of working and a pragmatic 5-year plan. Currently, many of the fresh start-ups opt for an LLC but later in future, they find out that an S Corp or C Corp type structure was more suitable to their business type.
Following are a few points that would help you to not fall into the dilemma trap of an LLC or an S Corp.
A Limited Liability Company or an LLC as we say, is a business entity that separates itself from terms like, ‘owners’ and concentrates on saying ‘members’, in general. An LLC is more flexible than any other form business structure. It also requires less paperwork and obligations than a corporation.
Whereas, an S Corp or a Sub-Chapter Corporation meets specific Internal Revenue Code requirements, where, it gives corporation no more than 100 shareholders. Here, a corporation directly passes the income to shareholder and avoids double taxation.
LLC as a structure is more flexible as any citizen- the U.S or non-U.S citizens can be its members; S Corps on another hand may not take or have non-U.S citizens/shareholders.
S Corp has to be managed under strict mandatory rules than LLC. An LLC pays taxes to the IRS generally in quarterly forms. Some owners have a problem with this system and end up breaking the tax deadlines. In such cases forming any corporation like S Corps is a better option as they can pay taxes using payroll services, where taxes are automatically cut from their pay.
Owners of S corps don’t get paychecks, they receive a dividend, and their taxes are also based on a dividend, whereas owners of LLC are taxed on a partnership basis. LLC members also pay self-employment tax whereas corporate owners pay tax according to their employment income.
Profits And Losses
Profits and Losses are the main segments of a business, in an LLC profits and losses are shared to the members according to their share of membership.
LLC members (owners) have an equal interest in the asset of business; S Corps owners have a share of stocks. For example, in S Corp a shareholder of 50% stock would receive a 50% profit and loss, whereas in LLC a member 50% ownership can receive up to 90% of profit and loss. In S Corps profits and losses are dealt with by the corporation and are not passed to any owner directly. Due to additional payroll taxes and state corporate taxes charges, an S Corp owner has to pay more than an LLC worker. LLC is a pass through a business entity, here profits and losses are passing through to the individuals, and here the business income is considered the owner’s or member’s income
S Corp and LLC have different types of management. S Corps have a board of directors, employees and officers, whereas LLC is more onto sole proprietorship. As long as IRS rules are met, S crop stocks are freely transferable but an LLC ownership is not freely transferable, as it requires other member’s permission too.
The ongoing formality in both of these structures S Corp and LLC are completely different. Adopting bylaws, issuing stocks, annual directors, shareholders meeting etc. are key features in S Corp, whereas issuing membership shares, annual member meeting, The LLC is manager managed and documents all major company decision.
State Rules For Both Of These Subjects
The S Corp will have an upper hand, if we look at factors like ease of raising capital, ease of adding owners/ transferring an ownership interest, perpetual duration of the business and business taxed at the entity level.
State Corporation has imposed certain obligations on both of these subjects which includes, appointing and maintaining a registered agent, filing annual reports, paying annual fees, notifying the state about any kind of important changes in the company such as change of name.
An Important Advice
If you are already an LLC and unhappy with it, you can switch to tax free S Corporation but you can’t do it reverse. It’s a complex decision and one should not rush before taking a major decision, consulting a CPA or an attorney is always advisable, as tax consequences are a major deciding factor.