Starting your own small business is an ambitious endeavor that involves numerous important decisions. One of the first things to decide is how to classify your small business – today we’re going to compare two popular classifications, an S corporation and limited liability corporation (LLC). Each has their own sets of advantages and disadvantages – below is a brief overview to help you decide which is right for your business.
S Corporation (Inc.)
Advantages: of an S Corp
- No Two-Tiered Taxation. With an S corp, you can avoid double taxation. In other words, you will not have to pay personal taxes on top of corporate taxes for the same income.
- Personal Liability is Restricted. Should you find yourself in debt or facing a legal situation, only your business can be held liable – your personal assets are protected.
- Avoid FICA Taxes. Taxable income, as well as company contributions to retirement plans, is generally exempt from paying FICA taxes.
Disadvantages of an S Corp:
- Appreciated Asset Allocation is Taxed. If your assets appreciate, you will not be able to allocate them to yourself or employees without being taxed.
- Difficulty Withdrawing Assets. Withdrawing money can become a logistical nightmare with an S corp. Depending on how the withdrawal is characterized, it may come with payroll taxes, a W2 form or a loan document.
- Only One Stock of Class. S corps are only allowed to issue one stock class. This means that electing an S corp status, you must only have one class of shares. Violating this requirement (even accidentally) can result in severe tax consequences for your business and personal income tax return.
Limited Liability Company (LLC)
Advantages of an LLC:
- Unlimited Number of Shareholders. With an LLC, there is no limit to the number of members. While S corps are restricted to 100 shareholders, these restrictions do not apply to LLCs.
- No Restriction of Subsidiaries. Similarly, LLCs can have subsidiaries without restriction. Overall, the ownership regulations for LLCs are more relaxed than for S corps.
- Ongoing Formalities Not Required. While it is recommended for LLCs to follow certain formalities (creating an operating agreement, executing member meetings, etc.), such formalities are not required, as is the case for S corps.
Disadvantages of an LLC:
- Non-transferable Ownership. In most cases, LLC ownership may not be freely transferred and involves consent from other members, whereas S corps stock transferable.
- Possibility of Dissolution. The continued existence of LLCs is not always guaranteed. Various factors, such as the death of a member, can cause the LLC to dissolve.
- Different Self-Employment Taxes. LLCs involve a different tax structure than S corps, and S corps may be better because they may not have to pay self-employment taxes.
Although each route has clear advantages and disadvantages, each individual business situation is unique…and may change as your small business evolves and grows. Questions? Talk to our qualified business consulting professionals at Yeater & Associates, CPAs before making a decision to see which route is best for you!
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