Choosing Between an S Corporation and a Limited Liability Company (LLC)
By Karen J. Lange, The Company Corporation® Acknowledgement: Nolo Publishing, Legal Guide for Starting and Running a Small Business
It’s smart to protect personal assets from business debts and liabilities. Both owners of S Corporations and LLC’s enjoy limited personal liability. By contrast, sole proprietors and partners have unlimited personal risk.
Traditionally, business owners who chose to form an entity to protect personal assets but allow income/losses to be reported on a personal tax return had to create an S Corporation. Today, that can also be accomplished with an LLC. All 50 states and District of Columbia recognize LLC’s, and their popularity has soared. Nolo’s Legal Guide for Starting and Running a Small Business states, “For the majority of small businesses, the relative simplicity and flexibility of the LLC make it the better choice. This is especially true if your business will hold property, such as real estate, that’s likely to increase in value.”
Both S Corporations and LLC’s allow owners to avoid “double taxation” and to pay income taxes on a flow-through basis like sole proprietors and partners. However, LLC’s are quickly becoming a preferred entity among small business. Here are some key examples of the benefits of an LLC verses an S Corporation:
- An LLC is simpler and faster to form. It may be formed in one step, while an S Corporation election can only be made after a General Corporation is formed first.
- An LLC is not required to hold annual meetings or to keep formal minutes, while an S Corporation is required to do so.
- LLC members can split profits/losses in any way they choose. In an S corporation, shareholders must receive dividends according to the number of shares that they own, regardless of the amount of effort put into the business.
- An LLC can be owned by any combination of individuals or business entities. Only United States citizens and resident aliens may own an S Corporation. Other entities generally may not own an S Corporation.
While many business owners are enjoying the simplicity and flexibility of the LLC, it may not be the best choice in every case:
- Most states allow single-member LLC’s, however Massachusetts requires two members. Married owners often accommodate this by naming a spouse. If you prefer not to share ownership, you may need to form a Massachusetts corporation instead.
- Enticing or compensating employees with stock options or stock bonuses requires forming a corporation since LLC’s do not issue stock.
- S Corporation shareholders pay Medicare and Social Security tax only on money received as wages or salary, but not on profits received as dividends or that stay within the company. Under certain conditions, LLC members may need to pay Social Security and Medicare taxes on the entire amount of LLC profits. In particular, LLC’s that provide professional services such as health, law or engineering should consult a tax advisor on this issue.
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