S Corp or LLC- Which One is Right For Me?

S Corp or LLC- Which One is Right For Me?

The choice of business entity is arguably the most significant choice a new business has to make. It will establish the legal, tax, and equity structure of the business and how the owners interact and will be compensated.

The distinction between Sole Proprietorships, General Partnerships and C Corporations is fairly clear. However, the choice between S Corporations and Limited Liability Companies can be a very difficult one. This article will compare and contrast LLCs and S Corps from several important aspects in order to help you make a decision as to which form is best for your company.

1. Limited Liability

Both LLCs and S Corporations provide their owners with limited liability protection. All LLC members and S Corporations Shareholders' liability exposure is thus limited to their investment in the LLC or S Corporation. Neither entity will shield their owners from individual tort liability however.

2. Ease of Operation

As a general rule, the LLC is easier to operate and maintain than the S Corporation. There are far fewer forms required and start-up costs are less. Unlike S Corporations, LLCs are not required to have formal meetings or keep minutes (But it is still a good idea to keep them).

3. Ownership Restrictions

Almost any entity can be a member of an LLC. This is not the case for an S Corporation, only individuals and certain qualified trusts can own shares. In addition, non-resident aliens cannot be shareholders and the S Corporation cannot have more than 100 shareholders. For this purpose, a husband and wife count as one shareholder.

4. Tax Issues

a. Filing Requirements

An LLC files its tax returns on April 15 just like an individual and a single member LLC files a 1040 and a Schedule C. The LLC files a form 1065 Federal partnership return and the members each get K-1s. LLCs file State form 568 and have to pay an annual franchise fee of $800 and may have to pay a gross receipts tax as well.

b. Profit Allocation

LLCs can allocate profits, losses and expenses based upon agreement between the members. Thus, members who work more than other members can be allocated a higher percentage of income than their membership percentage.

S Corporations must allocate profits, losses, and expenses based upon an agreement between the members. Thus, members who work more than other members can be allocated a higher percentage of income than their membership percentage.

S Corporations must allocate profits and losses based strictly upon share ownership.

c. Employment Tax

LLC members are considered to be self-employed. As a result, all income from the LLC will be subject to the 15.3% self-employment and medicare tax.

In contrast, only the wages of S corporation employees are subject to employment taxes. Any remaining income paid to a shareholder will be treated as a "distribution" which may not be taxed at all in some cases.

While shareholders will be taxed on all S Corporation profits when reported, income and distributions won't always be taxed. If a shareholder is taxed on income, but does not take a distribution, then new distributions won't be taxed until prior years taxed amounts are distributed.

Although this sounds good, there is one more issue to consider. Shareholders who work for the S Corporation must be paid reasonable compensation for the work they perform.

Thus, if you work as an attorney, you can't show a ten dollar an hour pay rate and allocate the remainder to "distributions". This may bring unwelcome IRS attention.

d. Treatment of Debt

Members of an LLC can add LLC debt proportionately to their tax basis in their membership interest. This is important if the LLC will have losses. Often newly formed LLCs will have losses so this characteristic can be quite valuable. Shareholders of S Corporations can only increase their share basis by loans they personally make to S Corporation.

e. S Corporation is a prior C Corporation with Earnings and Profits

If an S Corporation was a regular C Corporation before making the S Corporation election, things can become quite complicated, especially if the C Corporation had accumulated earnings and profits.

Talk to a Lawyer

Need help? Start here.

How it Works

  1. Briefly tell us about your case
  2. Provide your contact information
  3. Choose attorneys to contact you
Get Professional Help

Talk to a Business Law attorney.

How It Works

  1. Briefly tell us about your case
  2. Provide your contact information
  3. Choose attorneys to contact you