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Differences Between LLCs and S-Corps
by
Michael N. Cohen
The most common decision for smaller start up companies is whether to form a
LLC or corporation with a "s election". Both entities have many similarities
such as limited liability protection of personal assets against lawsuits and
debts. However, there are several differences, especially in regards to
taxation. Although there is a lot of information regarding s-corporations and
LLC's in general, there is very little available that breaks down the important
differences. Below I have summarized the major characteristics and issues
associated with each entity:
I. S-Corporation
A. Liability
- 1. Shareholders granted personal protection from debts and liabilities
of business (like c-corp and LLC)
B. Taxation
- Pass through: Profits and losses pass through the corp and
reported to the individual tax return of shareholder (same as partnership
and LLC)
- 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.
- 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.
- Franchise Tax: Franchise Tax is waived your first year. LLC on
the other hand, must pay franchise tax its first year. S-Corp must pay the
CA Franchise Tax board either a 1.5% tax on net CA income or $800, whichever
is greater.
- 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
- Must file an S-Corporation annual income tax return each year (IRS Form
1120S)
- Must file annual report with Secretary of State, and a reporting fee of
$25 and a statement of information are required 90 days after formation.
- 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
- No more than 100 shareholders
- Shareholders must be US citizens or have US residency status
- Shareholders must be individuals (not corporations or partnerships)
- Only one class of stock (but different voting rights permitted, and same
rights to participate in dividends and sale of assets)
- 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
- Pass through: Profits and losses pass through the LLC and
reported to the individual tax return of shareholder (same as partnership
and Corps).
- Self-Employment Tax: LLC members must pay self-employment tax on
all income from the LLC.
- 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.
- Franchise Tax: 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.
- 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
- Very little formalities required. Operating agreement is recommended,
annual meetings not required.
- A reporting fee of $25 and a statement of information are required 90
days after formation and then every two years.
D. Other Characteristics
- Licensed professional in California must form a Professional Corporation
instead.
- Owners are called "members"
- Members may be individuals or separate legal entity such as a
corporation.
- 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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