S-Corp or LLC for Your Business
Before you form your new company, educate yourself about the differences between the business entities you could choose. Your choice will have a lasting effect on your business’s finances, legal status, and tax requirements.
For most small, closely held, and family businesses, your choice will come down to an S-Corporation or an LLC. An S-Corp is just a standard corporation that files Form 2553 with the IRS. This election distinguishes S-Corporations from C-Corporations and has an effect on how the corporation is taxed.
S-Corp vs. LLC Formation
S-Corps are less expensive to form initially, but must pay an annual franchise tax to the state. The wages the S-Corp pays determines how much its franchise tax is, which may be the minimum tax of $100, the maximum tax of $10,000, or somewhere in between. When filing taxes, an S-Corp must file a separate tax return to account for its income and expenses, which may cost an S-Corp owner more if the business hires an accountant.
A limited liability company is more expensive to form initially because it has a publication requirement in many states. In addition to the formation costs that accompany the Articles of Organization filing with the Secretary of State, the LLC must pay to publish notification about its formation in two different newspapers for a period of 6 weeks. Additionally, LLCs — like S-Corps — pay an annual fee based on the LLC’s yearly income. The annual fee typically falls between $25 and $4,500.
LLC vs. S-Corporation Taxation
Both S-Corps and LLCs are considered pass-through tax entities, which means income is recorded on the individual owner or owners’ own income tax returns. Additionally, both multi-member LLCs and S-Corps must file an informational tax return annually with the IRS. No tax is due with these returns as the tax is paid by the individual owners. Single-member LLCs, unlike S-Corps, do not need to file any separate return.
Both LLC and S-Corporation income is subject to self-employment tax.
S-Corporation and LLC Legal Differences
An S-Corp offers limited liability for its owners. This means that the owners are (generally) not personally liable for the debts of the business. Owners are referred to as “shareholders” and are said to hold stock in the company. This does not mean that all S-Corporations are traded on the stock market; closely held S-Corps may issue stock to a small selected group of individuals with no public trading. Other businesses are not permitted to be shareholders, and foreign citizens may also not hold stock.
LLCs also give their owners personal liability protection. Owners are referred to as “members” and are said to hold an interest in the company. Like S-Corps, interest may be given to a small selected group of individuals (or even to only a single individual). Unlike S-Corps, there is no limit to the number of members an LLC may have. Additionally, there is no restriction on who can be a member; both foreign citizens and other business entities may own an interest in a limited liability company.
S-Corporations are older entities than LLCs and therefore have a richer and more robust history. This makes the S-Corp a bit more legally predictable, but this difference is shrinking each year. As a trade-off, limited liability companies are more legally flexible.
Whatever your entity selection, you should consult a licensed business attorney so that you are sure you make the best decision for your company. Later switching from an LLC to an S-Corp or from an S-Corp to an LLC can be difficult and may require you to completely dissolve and reform your business.