If you have decided to start your own business, one of the first decisions you need to make is how you want to structure your entity. There are advantages and disadvantages to both limited liability corporations (LLCs) and S corporations, and the decision can be a difficult one.
An LLC is a streamlined business structure that combines the pass-through taxation of a partnership or sole proprietorship with the limited liability of a corporation. Some advantages and disadvantages of electing to form an LLC include:
- LLCs are easy to set up, usually requiring only a single page form for a single member LLC. They are also easy to operate and inexpensive to start (often costing just a couple of hundred dollars).
- You can protect your personal assets from creditors of your business. With an LLC, you cannot be held responsible for more than your investment in the company. For example, if you invest $25,000 in your business and incur $50,000 worth of debt, you can only be held liable for $25,000.
- LLCs are considered “pass-through entities” for taxation purposes. This means that all your business’ income and expenses will be reported on your personal tax return. Pre-tax expenses including travel, computers, phone bills, advertising, car expenses and health care premiums may be deductible in certain situations.
- If your business holds property, such as real estate, the LLC will not be subject to a double tax on the increased value of the property when the property is sold or liquidated, as would be the case with a corporation.
- Single member LLC owners must pay self-employment tax on income generated by the business. This may amount to approximately 15 percent of your business’ revenue.
- LLCs are very flexible for income tax purposes. Owners can elect to pay taxes as a sole proprietorship, a C corporation, an S corporation, or a partnership if it has multiple owners.
The S Corporation
If you are considering forming a corporation instead of an LLC, you can elect to form either a C corporation or an S corporation (named after subsection S of Chapter 1 of the Internal Revenue Code). The C corporation is a standard corporation, and S corporations are flow-through entities, meaning that the corporation is not itself subject to income tax. Rather, shareholders of the S corp are subject to tax on their pro rata shares of income based on their shareholdings.
Some advantages and disadvantages of electing to form an S Corporation include:
- S corps pay employees (including owners/officers) a “reasonable” salary while deducting payroll expenses such as federal taxes and FICA. Any profits in excess of these deductions can be distributed to the owners as dividends, which may be taxed at a lower rate than income. Many would consider this to be the major advantage of forming an S corp. Shareholders should be cautious about setting a “reasonable” salary consistent with industry standards, as the IRS is increasingly cracking down on S corps for abusing this rule.
- Forming an S corp costs a considerable amount more than forming an LLC, and the process is more complicated and time-consuming.
- To form an S corp, one must meet the following conditions:
- All shareholders must be a U.S. citizens or residents
- The business cannot have more than 100 shareholders
- Your corporation can only have one class of stock
- The business’ profits and losses must be distributed to shareholders in proportion to their interest. For example, if a shareholder owns 33 percent of the S corp, they must receive 33 percent of the profits or losses.
- S corps cannot have more than 25 percent of their gross income generated by passive activities like real estate investment
- S corps may have to pay additional state or local taxes.
- S corps are more difficult to run, requiring owners to hold meetings, keep minutes, make resolutions, elect officers and generate formal financial statements.
- Investors and bankers may be more comfortable dealing with an S corp because it creates more separation between the individual owner and the company itself.
Brooklyn Business Lawyer Regina Gordon Counsels Entrepreneurs on How to Structure Their New Businesses
In most situations, it will be to a new business owner’s advantage to set up an LLC, because it is easier and cheaper to organize and administer than an S corp. However, every situation is unique. The preceding is merely intended as an overview and does not constitute tax or legal advice. There are many exceptions to these rules, and if you have questions about your particular situation, we advise that you speak with an accountant or business lawyer.
To learn more about what entity structure is best for your new business, speak to an experienced New York business lawyer at Regina Gordon Law Office today. We serve clients online throughout New York State, including Long Island, New York City (NYC), Brooklyn, Manhattan, Queens, Bronx and Staten Island. Contact us at 347-770-7507 or submit a convenient online inquiry.