LLC vs. S Corp – Which One is Right for You?

So you have finally decided to start your own business – Congratulations! Now is the time to make some very important decisions before you move forward in the formation of your company. One of the most important and impactful decisions you will make is in regards to the legal structure of your company. While there are several options to consider, including sole proprietorship, C Corporation, Partnership, Limited Liability Company(or LLC) and S Corporation, our intent here is to discuss the pros and cons of selecting an LLC versus an S Corporation.

Differences between LLC and S Corporation

First we will cover the differences between these two types of legal organization. A Limited Liability Company (LLC) is the United States form of a private limited company. The structure of this type of organization combines the pass-through taxation of a partnership or sole proprietorship with the limited liability of a corporation. An S Corporation (or S Corp)is a closely held corporation that makes an election on their federal income tax return to be taxed under Subchapter S of Chapter 1 of the Internal Revenue Code. A corporation is eligible to be taxed as an S corporation if it has no more than 100 shareholders and the shareholders are all individuals, has no nonresident aliens as shareholders and has only one class of stock. Broadly speaking, S Corporations do not pay any federal income taxes. The corporation’s income or losses will be divided amongst the shareholders and then the shareholders must report the income or loss on their personal tax returns. This avoids double taxation.

Pros and Cons of an LLC

Positive aspects of an LLC include liability protection as well as pass-through taxation. An LLC is also allowed to have an unlimited number of owners (members) as well as non-U.S. citizens and non-U.S. residents. LLCs may also be owned by any other type of corporate entity and face much less regulation in regards to the formation of subsidiaries. An LLC operating agreement is also a very flexible document which grants the members the ability to set up their business to maximize their preferred methods of operation. Drawbacks of electing an LLC structure includes the regulations regarding transfers of ownership as well as the requirement to use accrual accounting only (with a few exceptions allowed).

Pros and Cons of an S Corporation

The positive side of the equation for S Corporations include the ability to choose from either accrual accounting or cash basis accounting, typically a perpetual existence, and the ability to have access to substantial outside financing. An S corporation can also issue common stock and the stock is freely transferable. On the negative or con side of the equation is the relatively higher cost for initial setup as well as ongoing operational regulation, such as adoption of corporate bylaws, conducting initial and annual shareholder meetings, keeping the minutes of company meetings and the regulations they are required to follow when issuing stock in the company. S corporations must also select a board of directors and corporate officers.

Which One is Right for You?

So which one should you choose for your new business venture? A few key questions should help you solve for that answer. If you are looking to maximize your personal asset protection and you plan to seek large outside investors and envision selling common stock at some point in the future, then a C corporation with an S corporation tax election is probably your best choice.

If you are looking for flexibility in how you manage your business, then an LLC is probably more beneficial. An LLC will allow you to have a minimum of corporate paperwork, an unlimited number of owners (members), non-U.S. citizens and non-U.S. residents are allowed as owners as well as other corporate entities. LLCs are also not required to keep and maintain records of their company meetings. There are two primary drawbacks to forming an LLC versus an S Corporation. The first one is the limitation on accounting methods. The LLC typically can only use accrual accounting and cannot use cash basis accounting, with a few exceptions. Transfer of LLC ownership usually has to be approved by the other owners.

One final note is regarding your individual state’s laws and regulations regarding incorporation. It is always a good idea to consult with a corporate attorney and/or an accountant so that you may make an informed decision.

There are many factors that will help determine what type of business entity is the best match for your specific business. Making that decision may seem daunting, but with these key points to consider, you are well on your way to discovering which one will work best for you and your new business venture. Congratulations and best wishes for your success!