For many, owning your own business is the essential American dream.
What starts as an idea can grow into a business plan, but there are a lot of financial and legal considerations you should take in the process.
One of the first and most important decisions new business owners face is how they want to structure their business entity. For most, this means deciding between a Limited Liability Company (LLC) or an S Corporation. There are plenty of similarities between the two, but also plenty of differences, so before you choose one or the other, let’s explore them both.
- Both entities require filing paperwork with the state. Unlike a sole proprietorship, you are not recognized as a legal business until that paperwork has been filed.
- Both entities provide owners with limited liability, meaning your personal assets are protected from your business creditors’ claims.
- Provided an LLC doesn’t choose to be taxed as a C Corporation, an LLC and S Corporation allow business profits and losses to flow through the business and to be reported on the owners’ personal tax returns.
- LLCs may have an unlimited number of owners and different types of owners. S Corporations have more strict ownership rules. They can have no more than 100 shareholders; they may not have non-U.S. citizen shareholders; they cannot be owned by corporations, LLCs, partnerships or many types of trusts.
- As opposed to LLCs, which have flexibility in structuring the economic arrangement among its owners, S corporations cannot issue classes of stock with different economic rights. However, an S corporation can issue voting and non-voting classes of stock.
- There are mandatory requirements for how an S Corporation is managed. They are often required to adopt bylaws, issue stock, hold regular meetings, and maintain meeting minutes with corporate records, none of which LLCs are required to do.
- Owners of S Corporations, unlike LLCs, may be able to reduce or eliminate the need to pay self-employment tax. An S corporation owner can be treated as an employee and paid a reasonable salary. Employment taxes are withheld from the reasonable salary, while corporate earnings in excess of that salary may be distributed to the owners as unearned income, free of self-employment tax.
- Profits are split among owners differently, with S Corporation owners being required to split them evenly, while LLC owners have more flexibility in how they want to split profits and losses among ownership.
- LLCs are generally less expensive to form and operate.
- Corporations generally provide enhanced asset protection, as the structure creates more separation between the owners and the company.
For most small business owners, an LLC makes the most sense, but each business has its own unique circumstances to consider, so don’t try and make the decision alone. Reach out to an experienced small business attorney for advice on how to properly structure, form and protect your business. Don’t let your American dream be destroyed before it even begins!