While S Corporations and LLCs fall under different categories—the former being a tax status and the latter being a legal entity—they are each relevant concepts to know for aspiring business owners. As you grow your small business, you should consider the implications of each of these concepts. Using what you learn from this guide, you can avoid complications and save yourself some money down the road.
Under many circumstances, when you found a business you are also personally responsible for the debts incurred by your company. In this case, if your business is the target of a lawsuit, your personal assets could be in danger. If, however, you establish your business as a limited liability company, you protect yourself from liability for debts incurred by your business.
If there are multiple owners of your business, it would be considered a multi-member LLC. On the other hand, if you are the sole owner of your LLC, it would be called a single-member LLC.
LLCs offer similar protections to corporations, but with fewer recordkeeping requirements. While the owners of corporations are called shareholders, LLC owners are referred to as members.
Shareholders can transfer their shares to others, while members have restrictions placed on their membership interests. Corporations are better if you are planning to look for outside help from investors, whilst LLCs are often better for small businesses seeking more flexibility.
S Corporations Explained
An S corp. is a tax designation that comes in handy for business owners. Specifically, S corporations allow profits from a business to be transferred onto an owner’s individual tax returns. This is called pass-through taxation and assures that you avoid being double-taxed on a sum of money.
Before establishing an S corp., you must first create either a corporation or an LLC by filing the appropriate state paperwork. Then, for your business to qualify., it must have less than or equal to 100 shareholders. Each of those shareholders must be a U.S. citizen.
Owner Employment: The Advantages
LLCs and S corporations are each eligible to employ their owners with a salary. This can be advantageous for tax purposes. Owner-employees also have the advantage of eligibility for company benefit programs such as 401k.
Rules and Regulations of Stock and Shareholders
S corporations can give voting rights to their shareholders in the form of common stock. In contrast, LLCs do not have shareholders and cannot issue stock. Additionally, in an LLC you have to be mindful of the LLC’s articles of organization when paying members. In the case that your LLC classifies as an S corp., your company can’t have shareholders or issue stock.
The Advantages of an LLC
If you don’t want to be personally liable for your company, it’s beneficial to establish an LLC. While corporations also exempt you from liability, LLCs have the added benefit of more flexibility for small businesses. Additionally, when your LLC classifies as an S Corp., you can also avoid double taxation.
The Advantages of S Corp.
S corp. tax classification is a tremendous help when your business is rapidly expanding. There is a drawback of S corporations in that it requires more tax forms and payroll systems, so keep that in mind. However, when your business is consistently growing, S corp. tax classification may be best for you.
When you first start a business, there are a lot of difficult choices to make. When deciding between establishing your business as an LLC, an S corp., or both, first you must evaluate your overall business goals. Once you do so, you can make an informed decision.
To learn more about the subject of LLCs vs S corporations, take a look at the infographic below.
Please include attribution to LegalZoom.com with this graphic.