Differences Between LLC's and S-Corps

by Michael N. Cohen

When choosing to incorporate, the most common decision smaller businesses face is  what form of business to operate under.  Here is a comparison between LLCs and S Corporations to help you determine which might be better for you.

What is the difference between an LLC and an S Corp? When choosing to incorporate, the most common decision smaller businesses face is which type of corporation to form. Here is a comparison between LLCs and S-Corporations.

I. S-Corporation

A. Liability

  1. 1. Shareholders granted personal protection from debts and liabilities of business (like c-corp and LLC)

B. Taxation

  1. Pass through: Profits and losses pass through the corp and reported to the individual tax return of shareholder (same as partnership and LLC)
     
  2. Self-Employment Tax Break: Profits of the S-Corp which pass through to the shareholders are not subject to self-employment tax (Social Security and Medicare which is approximately 15%). Rather, self-employment is only taxed on the portion classified as a "reasonable salary". LLCs and sole-proprietorships must pay self-employment tax on all income. The ability to minimize self-employment tax is deemed to be one of the greatest benefits of a s-corporation.
     
  3. Corporate Losses: losses in the corporation can be deducted from the individual tax returns of the shareholder thereby allowing them to offset other sources of income such as their W-2 income.
     
  4. Franchise Tax: The Franchise Tax rules for LLCs and S Corps vary from state to state. Check with your state government or your personal attorney or CPA to determine how the tax varies based on which form of business you choose.
  5. Distribution of Profits and Losses: No special allocation of profit and losses for shareholders. Corporate profits and losses must be split up proportionately to the percentage of shares owned by each shareholder. LLC's on the otherhand allow for flexibility as to how they split their profits and losses.


C. Formalities

  1. Must file an S-Corporation annual income tax return each year (IRS Form 1120S)
     
  2. Must file annual report with Secretary of State. In California, a reporting fee of $25 and a statement of information are required 90 days after formation.
     
  3. Must maintain corporate formalities such as: Drafting Bylaws, Minutes, Annual Meetings, issuance of stock, to keep a paper a trail of financial dealings between the corporation and its shareholders, and to avoid "piercing of the corporate veil."

D. Other Characteristics

  1. No more than 100 shareholders
     
  2. Shareholders must be US citizens or have US residency status
     
  3. Shareholders must be individuals (not corporations or partnerships)
     
  4. Only one class of stock (but different voting rights permitted, and same rights to participate in dividends and sale of assets)
     
  5. Owners are called "shareholders"

II. LLC

A. Liability: shareholders granted personal protection from debts and liabilities of business (like s and c-corp)

B. Taxation

  1. Pass through: Profits and losses pass through the LLC and reported to the individual tax return of shareholder (same as partnership and Corps).
     
  2. Self-Employment Tax: LLC members must pay self-employment tax on all income from the LLC.
     
  3. LLC Losses: losses in the LLC can be deducted from the individual tax returns of the member thereby allowing them to offset other sources of income such as their W-2 income.
     
  4. Franchise Tax: Varies by state. In California, you must pay first year minimum annual tax of $800, and is due 75 days after formation and every year thereafter. Annual franchise tax is greater if total reported income is greater than $250,000. See http://www.ftb.ca.gov/forms/06_forms/06_3522.pdf.
     
  5. Distribution of Profits and Losses: It is flexible since an LLC allows you to decide what share of the LLC profits and losses each owner will receive.

C. Formalities

  1. Very little formalities required. Operating agreement is recommended, annual meetings not required.
     
  2. In California, a reporting fee of $25 and a statement of information are required 90 days after formation and then every two years.

D. Other Characteristics

  1. Licensed professional in California must form a Professional Corporation instead.
     
  2. Owners are called "members"
     
  3. Members may be individuals or separate legal entity such as a corporation.
     
  4. Member's investment receives a percentage ownership interest in return. Percentage ownership determines how profit and losses are split up.

Copyright 2006 Michael N. Cohen, Esq.

This article is not intended as a substitute for legal advice. The specific facts that apply to your matter may make the outcome different than would be anticipated by you. You should consult with an attorney familiar with the issues and the laws.

Mr. Cohen is the founder and principal of the Law Office of Michael N. Cohen. Mr. Cohen is registered to practice before the United States Patent and Trademark Office as a patent attorney and has an expertise in the following areas: Patent infringement, copyright infringement, and trademark infringement. Visit his web site at http://www.patentlawip.com.

 

 
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