S corp or LLC?

By Nicholas Pell | Small Business

When deciding to incorporate the first decision is what type of corporation to form.

If you are self-employed you are likely hemorrhaging money on taxes by not being incorporated. For small proprietors it is hard to know which is the better option -- S-Corp or Limited Liability Corporation. Considering the pros and cons of both will help you make the best decision for you and your business.

Features of an S-Corp

S-Corporations have the benefit of single taxation, meaning that only dividends are taxed -- not the corporation’s profits. This gives small businesses benefits normally removed for large companies. Some features of the S-Corp include:

  • · S-Corps must be filed with your state, with filing fees varying from one place to another.
  • · Shareholders are not liable for corporate debt, nor is the corporation liable for individual debt.
  • · Shareholders must elect a board of directors and officers, hold meetings at least once per year and file annual reports.
  • · An S-Corp exists in perpetuity, with the life of the corporation extending past the death of a shareholder or his withdrawal from the corporation.
  • · S-Corps are not taxed in most circumstances. The income you make from an S-Corp is taxed, however.
  • · Your salary is subject to the federal self-employment tax, however your dividends are not.
  • · S-Corps can sell shares to raise capital , however corporations cannot own stock in an S-Corp in most circumstances.

The S-Corp is an attractive and easy option for individuals looking to avoid paying the self-employment tax in a legal manner.

Features of an LLC

Limited liability corporations are similar in S-Corporations in many ways. Some features of the LLC include:

  • · State-level filing, with requirements changing from one state to another.
  • · No liability for individual members.
  • · Very few requirements in the way of administration.
  • · Members are allowed to choose whatever managerial structure makes sense.
  • · Exemption from corporate taxation. Shareholders are taxed at the individual level.
  • · LLC s might be perpetual or have a fixed term depending on state law.
  • · Shareholders may sell their interest, but these are subject to the operating agreement as well as securities law.
  • · Requirements for operation vary from one state to another.

You might prefer an LLC because of its more flexible operating requirements.

Advantages and Disadvantages

One key advantage of both forms is paying less in tax as well as providing liability protection for shareholders. Additional advantages of the LLC include:

  • · No requirement to keep minutes.
  • · Flexibility in profit distribution.

The LLC is not without disadvantages, however. Some drawbacks of the LLC as compared to an S-Corporation include:

  • · LLCs must be dissolved when a member dies or when a member goes through bankruptcy.
  • · LLCs are forbidden from issuing shares for raising capital or any other reason.

A disadvantage of both forms is that taxation is far more complicated. The corporate tax code is nearly impossible to navigate unless you have specialized training as a certified public accountant.

Choosing The Right Way to Incorporate

The LLC has largely become a thing of the past because of the S-Corp, however it is still preferred by some who prefer its more informal structure. This is, at the end of the day, the main difference between the two forms. Discussing your options with an accountant is the best way to determine which is the best option for you.

Photo courtesy of nep via Flickr

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