Ever wondered whether you should incorporate your business as a limited liability corporation or an S corporation.
Today we’re going to help you decide once and for all.
You’re ready to start a new business or maybe you’ve realized that its time to protect your existing business by going legit and protecting your personal assets from any potential litigation or maybe you’re just ready to tap into some of the tax benefits that come with business ownership. Whatever the reason may be, you’re probably trying to decide like many other entrepreneurs whether you should structure your business as Limited Liability Corporation (LLC), or an S Corporation (S Corp).
These structures have similarities and differences that can make choosing between them and other organization structures such as a (C Corp) confusing and nerve-wracking, likely leading to analysis paralysis. Which means you ultimately end up doing nothing!
If your business is large, it may be helpful to consult with a business legal consultant or an accountant as the laws and protections under each organizational structure can change based on your location.
One of the largest benefits of organizing your business as an LLC or an S-Corp is that you protect your personal assets from any potential legal implications or creditors that may be targeting your business. This includes but is not limited to being sued for any number of reasons, business debts, and hard financial times. “Limited Liability” means that you can’t and should not be held responsible for anything more than what you have invested in your company.
For example: If you put $50,000 into your business but something happens and you go $100,000 into debt, having an LLC or some type of protection will keep creditors from coming after your personal assets such as your home, car, and other businesses.
Having an LLC or an S-Corp also helps you to avoid having to pay both personal and corporate taxes. The main difference is S-Corp owners must pay themselves a salary, while an LLC is strictly a pass-through entity. Pass-through, meaning that your income and expenses go through your business and get reported on your personal tax return.
You can deduct pre-tax expenses such as uniforms, travel, technology, and marketing/advertising, etc under both organizational structures.
Now that we have a clear short understanding of the benefits that both LLCs and S-Corps share. It’s time to dive into the major differences and point out the pros and the cons for choosing one over the other based on the type of business that you have or that you are going to start.
- The owner (you) does not have to file a tax return for the LLC, you only have to report the activity on your personal tax return. (Profit, Loss, Expense)
- LLC’s are easier to setup. Most forms are just a single page for single-member LLCs.
- LLC’s are less expensive to file. The most you may pay is a couple of hundred dollars for complex structures/consulting.
- They are less complicated and less stringent overall. You won’t need to hire an accountant or attorney to guide you through the filing.
- Single-member LLC owners are required by law to pay self-employment tax on income generated through the LLC.
- LLC owners (you) must make sure that they operate “everything” dealing with their business separately from their personal affairs/assets. I.e Your business income should be routed to its own bank account and no directly into yours. Doing so would then make your personal assets seizable by creditors if they choose to dive deep into your finances.
There have been several cases where a business owner lost personal assets because their LLC was not operated cleanly separate from their personal affairs. You don’t want that!
- The biggest and most distinguishable benefit of operating under an S-Corp vs an LLC is the larger tax benefits. Under an S-Corp each member or “employee” is paid a reasonable salary, while also deducting regular payroll taxes and expenses. Whatever is left after salaries have been paid can be paid out as dividends which are taxed much lower than traditional income. This allows the possibility of putting more money into the owner’s pockets by diverting/circumventing the tax code.
- S-Corps have very strict guidelines, more strict than a traditional LLC. Per the IRS tax code. Your business must meet the following guidelines to create an S-Corp.
- You must be a U.S. citizen or resident.
- It cannot have more than 100 shareholders.
- The corporation can only have one class of stock.
- Profits and losses must be distributed to the shareholders in proportion to the shareholder’s interest. For example, you can’t have disproportionate distributions of dividends or losses. If a shareholder owns 10 percent of the S corp, he or she must receive 10 percent of the profits or losses.
- It cost significantly more to form an S-Corp.
- There are strict regulatory requirements of shareholders. If these requirements are violated you could risk the disallowing of the S-Corp.
- You must make sure the salary that you are paying yourself is in fact “reasonable” and not predatory/illusive. You could risk tax evasion charges for this.
- There can also be additional state taxes depending on the state where the S-Corp is registered.
As you can see, there are several strong benefits to operating as an S-Corp over an LLC. However, it is best for you to pick the one that closely fits your current operating structure. If you are just starting out an LLC should be sufficient to protect your personal assets. When your revenue is up and you begin forming a strong organization hierarchy with payroll and taxes then you can consider hiring an attorney and an accountant and making the switch to S-Corp which will then save you money in taxes.
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