Are you torn between choosing an S-Corp and LLC business structure? You are probably worried about how your choice will impact your tax obligations, personal liability, and company operations.
According to Statista, 21% of startup companies fail because of disharmony among team members, while 19% fail due to legal issues. You don’t want your company to suffer the same fate.
Understanding the characteristics, similarities, and differences of S-Corps and LLCs is the key to making an informed decision.
In this article, we will discuss the features, advantages, and disadvantages of both S-Corps and LLCs. We will also compare similar features and differences to provide a clearer understanding of both business entities.
Let’s get started.
What is an S-Corp?
An S-Corporation is a special type of corporation that chooses to pass corporate income, credits, deductions, and loss through to their shareholders for taxation purposes.
This means the corporation itself does not pay taxes. Instead, the tax obligations are passed through directly to shareholders’ individual tax returns.
This way, S-Corps avoid double taxation at the corporate and individual levels.
Advantages of an S-Corp
An S-Corporation provides several key benefits. Let’s take a close look.
As previously mentioned, S-Corps avoid double taxation that occurs with regular C-Corporations. This results in considerable tax savings.
The corporate tax rate varies by state. According to the Tax Foundation, New Jersey has the highest corporate tax at 11.5%.
It is followed closely by Minnesota at 9.8% and Illinois at 9.50%.
Limited Liability Protection
An S-Corp provides limited liability protection. This means the shareholders’ personal assets are protected from business debts and obligations.
S-Corps carry a more formal and professional image. This can be beneficial in certain industries and when seeking investment or financing.
Disadvantages of an S-Corp
While it has its benefits, an S-Corp also has its drawbacks.
Restrictions on Ownership
S-Corps have restrictions on the number and types of shareholders. An S-Corp can only have a maximum of 100 shareholders. Additionally, ownership is restricted to US citizens and residents, specific trusts, and estates.
S-Corps adhere to more formalities, such as holding regular meetings and maintaining accurate corporate records.
What is an LLC?
A Limited Liability Company (LLC) is a flexible business structure that combines the characteristics of a corporation and a partnership. It provides the liability protection of a corporation and the simplicity of a partnership.
Requirements to form an LLC may vary by state. Check your state’s requirements to have a better idea of what to expect.
While you may want to register an LLC yourself, the application process can be complex and overwhelming.
Luckily, GovDocFiling in the Inc Authority review guide, simplifies the process by providing a simple online form to apply for your LLC. The best part is that it is free. You will only need to pay the required state fee.
Advantages of an LLC
LLCs offer several benefits that you can consider when choosing a business structure. Let’s take a look at them.
Since LLCs combine aspects of partnerships and corporations, they are flexible in terms of management and tax obligations. These entities can be managed by members or a specific manager. They can also be taxed as a corporation or pass-through entity.
Fewer Ownership Restrictions
Most states don’t restrict LLC ownership. This means an LLC can be owned by various types of members, including corporations, individuals, and foreign investors. Unlike S-corporations, LLCs don’t restrict the number of maximum investors.
Like S-Corporations, LLCs provide limited liability protection, safeguarding members’ personal assets.
Drawbacks of an LLC
Like S-Corps, LLCS also have their disadvantages. Let’s take a closer look at a few.
LLC members file self-employment taxes on their share of the company’s profits. This can result in higher taxes compared to S-Corporations.
Less Formal Structure
Unlike S-Corporations, LLCs have a less formal structure. This can be disadvantageous if you wish to project a more corporate image.
An LLC may be dissolved in some states when a member joins or leaves the business. However, it can be formed again with new membership. You can avoid dissolution by enforcing an agreement for transferring, buying, or selling ownership.
Choosing Between S-Corp and LLC
There is no one-size-fits-all answer when it comes to the right business structure. Consider the following factors before making the ultimate decision.
Your Business Needs
Consider the size of your business, the number of owners and employees, and your long-term business goals.
An LLC would be suitable if you have a small to medium-sized business. On the other hand, an S-Corp might be a great choice if you want to attract investors for rapid business expansion.
Weigh the tax implications of both structures. While both offer pass-through taxation, you may still need to file self-employment taxes for an LLC. An S-Corp would be suitable if you want to save on taxes.
Both business structures shield your personal assets from business debts and liabilities. This means items like your house, vehicle, and other personal assets will be safe even when your business struggles financially.
In this case, you can decide based on your specific business needs. For instance, you may only have enough capital to start an LLC, making it the ideal choice.
The best way to be sure about your decision is by consulting a professional. Reach out to reputable accountants or lawyers who are well-versed in business structures.
They can help you understand the specific implications of each structure and ensure compliance with relevant laws.
In the S-Corp vs. LLC debate, there is no definitive answer. Choosing between these structures depends on your business goals, the number and type of owners, tax considerations, and operational preferences.
Consult with legal and financial professionals to ensure you make the right decision for your specific needs.