LLC or Corporation - Which Is Right For Your Business?

One of the top questions I have received from clients has been: What is the difference between an LLC and a corporation? When choosing a business entity to start a business there are many factors to consider when determining which entity is the best fit for your company and its goals. For small businesses, the two main choices are the "S" corporation and limited liability company ("LLC"). In this post, I will explain to you those differences and hopefully help you determine which form of business entity works best for your company.

"S" CORPORATION

Let's begin by explaining that in order to become an "S" corporation, the business is created as a standard "C" corporation. Once created with the state, you must make an election with the Internal Revenue Service choosing to be taxed under Subchapter "S" of the Internal Revenue Code ("IRS"). The form filed with the IRS is Form 2553.

Once your corporation becomes an "S" corporation, the "S" corporation allows the corporation to avoid the double taxation imposed on a standard "C" corporation, and instead allows it to be taxed as a partnership. Basically, the owners of an "S" corporation can pay themselves a reasonable salary (subject to FICA tax and other withholding requirements), but the remaining net earnings can be distributed as passive dividend income not subject to self employment tax. In other words, all income or losses derived from the entity "passes through" to the owners’ personal tax returns, which should generate a lower tax rate than the corporate income tax rate.

Who controls the business? The control over an "S" corporation depends on who holds the most shares in the company. For example, if one person holds one hundred percent of the shares, that owner has ultimate control over important decisions. However, that owner would be able to grant control to whomever he/she wishes. If there is more than one owner, the control over the company can be split between shareholder according to the articles of incorporation (a document that must be filed with a state in order to incorporate the business).

Another benefit of an "S" corporation is that the owners are protected by limited liability of the corporate entity. For example, if the corporation is sued or goes bankrupt, the only liability an owner will have for such debt is the amount of money invested in the corporation. Any personal assets of the shareholders in an "S" corporation cannot be touched by creditors as long as the business is conducted legally.

Additionally, "S" corporations have a perpetual existence. This means that even if the owner dies, the company continues.

LLC

Limited liability companies are a special kind of business entities that combine the benefits of partnerships and corporations with limited liability. The LLC is a more flexible entity with many more options. It does not have to comply with the formalities of a corporation, such as board meetings, shareholder meetings and the election of directors, which are just a few of the formalities a corporation must follow.

The key benefit for LLCs is the limited liability that each member enjoys. The members of LLCs are protected from the actions of the other members in that LLC, and are only responsible for their own negligent behavior.

Regarding LLCs taxation, LLCs are pass through entities. This means that the profits from the company pass directly through the company to the owners. Instead of the company itself being taxed and having to file a tax return, the owners of the LLC receive a percentage of the profits based on their ownership share (this is called “pro rata” share), and then those owners can report that income (less deductible business expenses) on their personal income taxes.

Unlike corporations, the control over the LLC can vary. You can choose to have a member-managed LLC where all the owners (members) participate in running the business together. Or in the contrary, you can have a manager-managed structure, where only designated members, or certain non-members run the business. Or, you can choose a combination of both. The operating agreement (an agreement among the LLCs members governing the LLC's business, and members' financial and managerial rights and duties) would decide who can make important decisions over the company. Additionally, contrary to corporations, if an owner of an LLC dies it can cause the LLC to be dissolved. In some cases, owners can vote to continue the LLC.

Selecting the appropriate entity is an important part of beginning any new business venture. You need to carefully consider the pros and cons of the legal, tax, and operational aspects of each business entity when deciding.

So now that you know the differences between an LLC and an "S" corporation, which one will you choose?

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