S Corp vs LLC – Which form of entity is the right one for me?

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We are often asked the question by new entrepreneurs and small business owners as to which is better for them to incorporate – S Corporation or a Limited Liability Company (LLC). One common advantage they offer is that they are preferred business structures because, unlike sole proprietorships and partnerships, both offer liability protection. This means that the owner of a company cannot be held personally responsible for the company’s debts. The personal assets of an owner are shielded from company liabilities.   The personal liability, which attaches to partners in a partnership, arises from Section 15 of the Uniform Partnership Act. In Black v Sullivan, 48 Cal. App.3d 557, 569, 122 Cal. Rptr. 119, 127 (1975), the partners of a partnership are jointly and severally liable for the conduct and torts injuring a third party committed by one of the partners

In researching the various business structures, one inevitably comes across the S corporation. S corps and LLCs are similar in that they are both “pass-through” entities for tax purposes; the income of these companies are passed through to their owners and reported on the owners’ personal income tax returns, thereby eliminating the double taxation incurred by owners of a standard corporation, or C corporation. (With a C corporation, the net business income is subject to corporate income tax, and the income remaining after the corporate income tax are taxed a second time when they are distributed as dividends to its owners who must then pay personal income tax.)

So what is the difference between an S corporation and an LLC? And which structure is right for you?

S corporations and LLCs have a lot in common and therefore often appeal to the same people. Two major things S-corps and LLCs have in common are:

  • Both provide protection against liabilities 
  • Both enable the owners to avoid double taxation as business losses and profits pass through to the owners.

The answer depends on your own unique situation. LLC offers more operational ease and flexibility compared to S Corporation whereas S Corporation can help you save on employment tax.

The decision between an S-corporation and an LLC usually comes down to these significant differences:

  • Employment Taxes: Owners (members) of an LLC must pay employment taxes on all profits passed through to their individual tax return. Owners of an S-corporation, however, only pay taxes on the salary and wages they receive from the S corporation. Self Employment taxes for 2009 are about 15.3%. If you expect to generate significant profit or your LLC is already generating a lot of profit, this difference alone can make it worth starting up as or switching to an S-corp. S Corporation owner(s) are also required to take a reasonable salary for the services they perform or the IRS can recategorize distributions made as salary.
  • Ease of Starting up and Operations: It is simpler to start an LLC than it is to start an S-corporation and, once operating, LLCs do not require regular corporate meetings and maintaining company minutes, both of which are required by S-corps.  This less paperwork and corporate compliances can make LLC a preferred choice for many new start ups.
  • Costs of Operations:  Many a times entrepreneurs ignore the fact as to how much would it costs to operate their entity. If they form a single member LLC which is considered as a disregarded entity by the Internal Revenue Service (IRS), then all they need to file is a Schedule C along with their 1040. If two or more members than they are required to file Form 1065 or if classified as corporation by filing Form 8832, than 1120S or 1120. In an S Corporation even if you have only one shareholder than you are always required to file Form 1120S. Corporate compliances for 1120S also could prove expensive as they are required to maintain minutes of meetings, conduct annual meeting, etc. Also Secretary of State may have higher annual charges on S Corporation than a LLC.  

So if you are debating between selecting a S-corporation or an LLC for your new start up, then it probably comes down to how much profit you expect to make and whether or not you can reasonably argue that some of that profit should not count as your salary. If this is the case, then consider an S-corp. If not, then it probably makes sense to go with the simpler LLC. It’s not difficult to switch from an LLC to an S-corporation, so it often is best to keep things simple at the beginning and then switch to an S-corporation later if it makes sense to do so. Most of the times selecting the best business structure for your business is not easy. It varies from person to person depending on many personal factors. We highly recommend that you email us your query and we could explain you much better as to which structure would be better for you.

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Disclaimer: To ensure compliance with requirements imposed by the IRS in Circular 230, we inform you that, unless we expressly state otherwise in this post any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any transaction or other matter addressed herein. GVA serves the Individual & SME community by offering a wide range of services, which typically are offered by a large HR consulting and Big 5 Accounting firms. Services include, Mobility services, Taxation, Incorporation, Accounting & Payroll processing services. GVA does not offer legal services or legal advice, but only generic information on legal subjects. GVA is not an attorney or law firm and not a substitute for an attorney or law firm. Do not make any decisions based on the contents of this post.

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  • prasad

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  • For yourself your owrsenhip if you are the date you did was increase your partner may have gain or loss all you report it for yourself your capital accounts and you report it for yourself.The date you now have single member llc and you report it depends on your capital accounts and provisions in the partnership agreement you are the only owner now and provisions in the only owner now and dont report it depends.