Evaluating Being a S Corporation vs. a Limited Liability Company / LLC
Choosing an Entity Type Which is Best for You and Your Business.
If you have just made the hardest decision of opting to go into business for yourself or if you have owned your own business for years, having a working knowledge of how your overall tax bill is determined can cost or save you thousands. Making the right decision for your business will be critical to both your short terms success as well as eventually how comfortable your retirement might be. To this end, setting up the right entity from day one is your best bet to ensure you pay no more taxes than are legally necessary. The job of your most trusted adviser, your CPA, is to assist and guide in this process being sure to ask questions and contemplate issues you might not have even known to be a concern. As a business owner or running your business, the options will appear to be daunting but these parameters will do much to “lift the veil’ on whether you want your business to be an S Corporation or an LLC.
Limited Liability Company.
Limited Liability Companies/LLC’s are legal in most, if not all, states where their respective legislatures approved them. LLC’s allow for some flexibility options that are not allowed in some other entity selections as well as some liability limitations that are not otherwise available for professional service companies, those where professionals, such as physicians, are required to have a professional license in order to practice.
Advantages of being an LLC include:
- Ease of formation. LLC’s do not require a Board of Directors or an election of Officers.
- Anyone or entity can have ownership in an LLC. This allows other corporations or those who are not citizens of the United States to be owners.
- Unlimited number of owners. Unlike S Corporations who are limited to 100 shareholders.
- No Annual Board of Directors or Shareholders Minutes Meetings.
- Allocation of Profits. In an LLC owners can allocate profits in any percentage to which they agree whereas an S Corporation has to allocate profits based upon ownership percentages.
- Professional Liability Limitation. A physician group, for example, would want to strongly consider an LLC vs. an S Corporation because in an LLC individual physicians would be protected from the professional liability issues of other doctors in the practice. However, a physician is generally not allowed to escape his own professional malfeasance. Please note that this liability limitation issue is for Professional Liability issues only and that all other general tort or civil liability issues of an LLC vs. an S Corporation are the same.
Congress passed in the mid 1950′s rules allowing owners to simplify their tax issues by the establishment of S Corporations. S Corporations, like LLC’s are “flow through entities” and as such pay no income taxes upon the preparation of their respective returns, as these profits “flow to” the owners returns where each respective owners pays their portions of income taxes on their respective pro rata profits.
Rules of being an S Corporation include:
- Having less than 100 shareholders.
- All shareholders have to be U.S. citizens or resident aliens.
- Have a calendar year-end.
- Have one class of stock.
Avoid the hype. Keeping these basis tenants in mind will do much to steer you to making a wise and informed decisions when setting up your corporation. Although you are required to have Board of Directors and to elect an Officer I find that many sole-business owners are very well suited to naming themselves to both of these positions. Also, when I have my own Annual Board of Directors Meetings I find that I do not “argue with myself” so my meetings are rather quick and efficient. Also unless you have a professional license such as a physician, engineer or lawyer there are no Professional Liability concerns.
Generally speaking S Corporations overall tax bill will be less than an LLC because by tax law all of the net earnings our of an LLC are subject to FICA/Medicaid/Payroll Taxes whereas only the W-2 or gross wages from an S Corporation are accordingly subject. Please not that tax law does require that all active S Corporation owners take a fair and reasonable salary given position or profit.
Choosing the right entity type will have many other significant tax, retirement and financial issues as well. Consulting with your trusted CPA and adviser is your best first step to making a wise and informed decision.