One of the key decisions a new business owner will make is whether to set up their business as an LLC or an S corporation, commonly referred to as a S Corp. A Limited Liability Company (LLC) is similar to an S corp in certain ways; both grant owners limited personal liability for the debts and actions of the business. LLCs are also like a partnership, providing easy and flexible management compared with an S Corp, with similar tax benefits.
There are some specific differences between an LLC and S Corp you need to consider before you incorporate.
LLCs and S Corporations are both "pass-through" entities for tax purposes. The income gained by both corporations is passed through directly to the owners or shareholders and reported on their personal income tax returns.
The LLC will have to file forms as either individuals, such as the 1040, or as partners, Form 1065.
The S Corp will have to file Federal and State income tax forms, as well as each shareholder filling their own 1040 E and/or 1040-ES forms.
LLCs allow the owners to divide up the profits at whatever percentage they choose, 60/40 or 70/30, for example.
An S Corp shareholder can only receive his percentage of shares as his percentage of profits. If he owns 15% of the shares, he will only ever get 15% of the profits.
LLC owners are considered to be self-employed. They must report their earnings as personal income and pay a "self-employment tax" of 15.3%, which goes toward Social Security and Medicare contributions. The entire net income of the LLCs business is subject to self-employment tax.
In S corporations, only the owner-employee must pay employment tax. The remaining income paid out to the shareholders is exempt.
LLCs require less paperwork and legal documentation than an S Corp. An S Corp issues stocks and shares certificates, appoints a board, and must keep minutes of all meetings and procedural decisions.
LLCs have no ownership restrictions. S corps are allowed up to 100 shareholders, but none of them can be nonresident aliens, other corporations, or LLCs.
Deciding Between an LLC and S Corp
LLCs and S Corps each have a lot of pros and cons, so have an accountant or tax lawyer familiar with your business help you decide which type of business is best for you before making any final decision.