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LLC vs. S Corporation | Which is Right for My Business?

I'm frequently approached (virtually) by entrepreneurs that have great ideas for a new business to start. They know that they need to form SOME type of business, but often they don't know much more than the terms "LLC" or "Corporation." That's by no means a knock on them, as most people don't have much reason to know the differences between various types of business entities, much less how their structure can have an effect of operations, management, distributions, taxes and liability. Very commonly, for the types of businesses I work with, the choice boils down to two primary options: the LLC and the S Corporation. 

The question of which of those two entities is appropriate for a new business is one of great debate amongst lawyers and accountants. Simply put, there is no one-size-fits-all answer. While practitioners may have a preference for one form over the other (I have a theory that younger practitioners prefer the LLC being as it's a newer animal), when someone asks the question, "should I form an LLC or an S Corp?," it's impossible for me to provide a real answer and my response is always the same, "let's talk about it." \

I need to know the specifics of how you plan to operate your business, who is going to be involved, what roles they will play, what assets are going to be held, how operations are going to be funded, and where an entrepreneur sees his or her business in 5, 10 or 20 years, amongst a host of other things. 

Usually, the choice of entity is going to center on a few very specific operational objectives- objectives that, unsurprisingly, typically involve money, and how to avoid paying too much of it to the government. In that sense, I always encourage business owners to consult with their accounts. From a legal standpoint, we can make anything*** work, but often it's going to be easier when the accountant has steered the ship in the right direction. That said, there are some very high-level differences between LLCs and S Corporations which I've pulled together into a handy chart for those that may be curious. 

So, to those inquisitive entrepreneurs, I'd encourage you to read a bit about the differences, and then let's talk about it. 

 

 

LLC

S Corp

Formation

Formed by filing Articles of Organization with the relevant state institution and paying applicable fees.

Formed by filing Articles of Incorporation with the applicable state institution, paying applicable fees, and filing form 2553 with the IRS.

Period of existence

Perpetual unless otherwise stated in the Articles

Perpetual unless otherwise stated.

Liability

Separate entity from its members for liability for company debts. No member is liable for business obligations solely by reason of being a member. Members are liable for taxes in proportion to their percentage ownership in the LLC. Managers are not liable solely by reason of being a manager.

Separate entity from its officers, directors and shareholders for liability for company debts. Shareholders are liable for company debts up to their capital contribution.  

Management

In a manager-managed LLC, the company is managed by elected or appointed managers. The managers do not need to be members of the LLC. In a member-managed LLC, membership is vested in the members.

Managed by elected officers and directors. Officers and directors do not need to be shareholders.

Taxation

May be taxed as a sole proprietorship, if only 1 member; a partnership, if more than 1 member under subchapter K, or a corporation, if an election is filed (Form 2553). Income and losses flow through to the members in proportion to their interest in the LLC. An LLC may elect to be taxed as a corporation by filing appropriate forms.

Taxed under IRC Subchapter S. Owners are permitted to be taxed as a pass-through entity, similar to (but not identical to) partnerships. Income and losses flow through to the shareholders in proportion to their interest in the company.

Who may be a shareholder/interest holder

LLCs may have an unlimited number of members. There are no limitations on who may be a member. Individuals, partnerships, corporations, other LLCs, trusts and foreign individuals are all acceptable.

Only individuals (and some certain qualified trusts. No nonresident alien shareholders, no more than 100 total shareholders.

Classes of stock or capital

LLCs may have multiple classes of capital.

S Corporations may only have one class of stock.

 

Michael F. Brennan is an attorney at the Virtual Attorney™ a virtual law office helping clients in Illinois, Wisconsin, and Minnesota with estate planning and small business legal needs. He can be reached at michael.brennan@mfblegal.com with questions or comments, or check out his website at www.thevirtualattorney.com.

The information contained herein is intended for informational purposes only and is not legal advice, nor is it intended to create an attorney-client relationship. For specific legal advice regarding a specific legal issue please contact me or another attorney for assistance.

By Michael Brennan

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LLC or S Corp.