One of the first things you must do when forming a business is decide on the type of structure you want to use. Many businesses begin as sole proprietorships or partnerships, and as they grow, the owners make the decision to change their business structure. The most common dilemma for an owner is deciding upon between LLC vs S Corp. Here are five things to know about the two business structures that could help you make the right decision.
Ownership and profits
The owners of an S Corp are shareholders while the owners of an LLC are members. Contrary to what many people believe, a limited liability company is not a corporation. Shares of stock represent an ownership interest and are only issued by corporations, such as an S Corp.
The importance of this distinction is that profits are usually distributed according to the financial contribution an owner made as represented by the number of shares a person owns. The more shares that you own, the greater will be the profits you receive. An LLC is not restricted by capital contributions. Its operating agreement may specify how profits will be distributed to the members regardless of each member’s financial contribution to the LLC.
Each member of an LLC can participate in the management of the business. There is no distinction between managers and owners as there is with an S Corp. Shareholders do not have management responsibilities or rights unless they also hold director positions the board of directors of the corporation or serve as officers, such as president, vice president or secretary.
An LLC can restrict management responsibilities to only specifically designated members. Some state laws authorize the hiring of an outside manager who is not a member.
Protection of owners from personal liability
When comparing the LLC vs S Corp, it is important to keep in mind that both business structures offer the owners protection from personal liability. For example, a lawsuit filed by a customer of either an LLC or an S Corp would be against the business and not against the shareholders or the members. If the customer obtains a judgment against the business, it can only collect it from the assets of the LLC or S Corp. The personal assets of the owners are protected.
An LLC might offer more flexibility when it comes to how it pays its taxes. LLCs have the ability to elect to be taxed as a partnership, as a corporation or as a sole proprietorship. The decision is largely based upon what is best for the owners. An S Corp can elect to pass profits and losses through to its shareholders who then declare them on their personal tax returns. This avoids the payment of taxes by both the corporate entity and the owners.
Complexity of operation
An S Corp is legally required to have a board of directors, shareholders and officers. While it is true that one person can fill all three roles, the record keeping of corporations make them more complex than limited liability companies.
There are many factors that go into the decision of using the LLC vs S Corp business structure. Business owners should weigh all of them carefully and review their decision with an attorney or an accountant.