Here are the pros and cons of the S-Corp and LLC to be considered when electing to incorporate your business
For those who have started a business or have their own business, the question has always been asked… should I have my company be setup as an S-Corp. or should it be setup as an LLC?
The question was usually followed by a serious of pros and cons of each structure. Of course, an S Corporation, in and of itself, is not an actual legal structure but a tax election that, previously, was designed for corporate structures and partnership entities such as the LLC.
The background behind this conversation deals with the benefits of both the S-Corporation and the LLC.
Tax benefits
The S-Corporation was an election made usually by a corporation taking advantage of certain tax benefits so long as certain pre-requisites/requirements were met and maintained. These mandates required all owners of the company to be US citizens and/or US permanent residents, limited to 100 shareholders, and maintaining one class of stock.
If these pre-requisites were met, corporations could take the election and avoid paying taxes on its corporate tax return (in many cases at the state level as well) and only paying income tax on the profits through the individual owner’s personal income tax return at individual income tax rates (usually more favorable).
Now, most know partnership entities like LLC’s do not pay partnership income taxes but do have to report their profits. The profits would also be subject to individual income tax rates since they would also need to be reported on the owner’s personal income tax return. However, LLCs, like most limited partnerships, would also incur an additional self-employment of 15.3% for all owners who actively participated in the business.
Liability considerations
Regarding liability, both corporations and LLC’s offer limited liability protection to its owners (i.e., that is an owner’s liability is limited to the amount of money he/she has invested into the business). However, LLCs generally provide protections for the company against its owners.
Therefore, if an owner were to engage in activity that led to him/her being liable and such liability would require an owner to pay out to satisfy the liability incurred (e.g., a lawsuit for causing a car accident), the creditors of such liability could try to collect from everything the owner owns to satisfy the liability. But, while these creditors could go after a great deal of the assets in the owner’s possession, they would not be able to take from the LLC’s assets. Such assets would be protected from the actions of the individual owner(s).
The protection also extends to the voting and managerial rights of the owner(s) (the creditors could seek to obtain the distributional interest of the owner(s)). Reason being, an interest in an LLC, like most limited partnerships, is not considered definable personal asset.
Unfortunately, corporations do not have the same level of protection.
Corporate shares of stock, unlike LLC ownership interest, are considered the personal asset of its owner. Therefore, shares are no different than furniture or car or jewelry. Therefore, if an owner of a corporation had a liability, it is conceivable the owner’s shares of stock could be given up to satisfy its debt, including the voting rights that come with it. It should be noted; a creditor of an owner cannot simply take assets of a corporation. However, it could affect the sale of assets held in a corporation should it have sufficient votes rights to do so.
Therefore, the comparisons between the hybrid structure of an LLC and a corporation dealt not only from a legal perspective but, also the tax perspective, when factoring an S Corporation election. Now, LLCs did have the ability to obtain the S election, but the process was not as simple and most, if not all, usually stayed as a partnership entity status (or disregarded entity status, meaning you filed as a sole proprietorship) for tax purposes. As a result of this separation, if you will, business owners and entrepreneurs generally could not or did not take advantage of both an S Corporation and an LLC.
Consequently, the selection process was relegated to play the game of which is comparatively better for what I’m doing or which of the two would have the least negative effect on my business.
However, in 2013, the IRS made taking the S election for LLCs easier. In fact, the election process for an LLC uses the same procedure as corporations. Also, if a business has been LLC for more than one year, it can still make the election now; however, the election will not be retroactive if the business has already filed its first tax return and such filing was not an S-Corp filing.
Now, business owners and entrepreneurs don’t have to choose between having an S Corporation and an LLC.
They can now have it their way and take advantage of the benefits of both.
Related content:
Consider the Flexibility of an LLC
