Lessons Learned: LLC or S Corp? March 17, 2016 08:00
Lucky for you, a St. Patrick's day FLASH SALE is currently going on in the shop. 2016 Planners are only $10.08 and 2016 Typeface Calendars are only $5.04. Snag them for yourself and a friend while supplies last! Enter discount code LUCKYME at checkout. (On our website you can only use one discount code at a time. So those pesky cents are a result of us wanting you to be able to purchase both a planner and calendar in one haul!) Sale ends at midnight tonight EST (3/17)!
Last week, thanks to Becky, we had a "really personal" blog post. Don't know about you, but I enjoyed it, the honesty, the vulnerability, and I really needed that reminder, I am never alone and I am not in control!
So, I've been slated with following that act with a technical lesson learned, so definitely a change in pace, and probably SUPER boring for most of you. But again, to the person that finds it helpful, you are very welcome!
Once you've decided to take the plunge and start a company one of the first things you have to do is make your company "legal". In order to do that, you have to decide what type of business or structure you will have. For a small start-up company like us it really boiled down to a Limited Liability Company (LLC) or an S Corporation (S Corp) (the two most popular organizational forms today). Today I'll discuss the similarities and differences between an LLC and an S Corp.
Let us first say that choosing the type of structure (LLC, S Corp, or C Corp) for you company is confusing at best. There is no right answer, the question is what is the best fit for your company now and what will set you correctly regarding your future goals. Each state might also have different rules that come into play. That's why you'll want to get some input from a respected accountant and/or attorney to help aid your decision. We are just sharing what we have learned along our journey (please correct us if anything we have learned is incorrect).
Lets get this party started with some definitions..
LLC: A limited liability company (LLC) is an unincorporated association, a hybrid entity that combines the tax flow-through aspects of a partnership with the liability protection of a corporation or a limited partnership.
S Corp: Named after subsection S of Chapter 1 of the Internal Revenue Code. An S Corporation is a special hybrid type of entity, the S corporation elects to have a different tax treatment than its traditional C corporation cousin. For most purposes, an S corporation is not a separate type of corporation. An S corporation operates in the same manner as a regular corporation except it typically eliminates the the risk of double taxation.
Corporation: A corporation has a legal status or existence that is separate both from the individual(s) who forms it and its owners (stockholders). The objective of incorporation is to create a separate corporate entity with all of its attendant attributes, such as the independent right to own corporate assets. Income is taxed at the corporate level, and, if dividends are distributed, at the individual level as well (where the risk of double taxation comes into play).
Similarities between an LLC and an S Corp...
- Both are separate legal entities created by a state filing.
- Both provide liability protection for their members/sharholders. This means your personal assets will be protected against debts, losses, and any court rulings against your business. You can't be financially responsible for more than your investment in the company.
- An LLC and an S Corp are both pass-through tax entities which means the income, losses, tax credits, and other tax items of the business flow through to the shareholders/managers and no income taxes are paid at the business level.
- When first registering your company in the state of North Carolina it costs $125 to register an LLC and an S Corp. However both require filing of an annual report, $25 for an S Corp and $200 for an LLC in North Carolina. So an LLC costs more to maintain. Not sure how that shakes out in other states.
- S Corps require a little more paperwork and are a little more difficult to set up.
- To raise capital, corporations often sell stocks. LLCs can only sell interests in their company.
- S Corps have strict rules for how to remain compliant. Required formalities include: adopting bylaws, issuing stock, holding initial and annual director and shareholder meetings, and keeping meeting minutes with corporate records, etc. LLCs only have recommended formalities. In fact, with an LLC Operating Agreement you can essentially create the management structure of your choosing.
- An LLC beats an S corporation for flexibility in allocating percentage of profits or losses among the owners.
- LLCs are not recognized outside of the United States typically.
- Non-U.S. citizens/residents can be members of LLCs; S corps may not have non-U.S. citizens/residents as shareholders.
- S Corps can only have 100 shareholders, LLCs have no limitation.
- The owner of a single member LLC doesn't have to file a tax return for the LLC, as they only report the activity on their personal tax return.
- Single member LLC owners are required to pay self-employment tax on income generated in the LLC.
- The key advantage of an S corp is that it offers tax benefits when it comes to excess profits, known as distributions. The owner can be treated as an employee and paid a reasonable salary (tied to industry norms). FICA taxes are withheld and paid on that amount. Then, any remaining profits from the company can be distributed to the owners as dividends, which are taxed at a lower rate than income.
- LLCs have more flexible tax reporting options. S Corps must file taxes as S Corps, as an LLC you can elect to be taxed as an S corp while retaining the structure of an LLC.
Based on all the facts above we chose to be a Partnership LLC but elect to be taxed as an S Corp.
- By default since we are an LLC with more than one member we are treated as a partnership LLC. No choice there.
- We don't have anything squirrely going on with our percentages, everything is 50/50, gains and losses.
- We don't plan to find investors any time soon (especially not from overseas).
- We get the flexibility of how we want to organize our company.
- There are less formalities and paperwork associated.
- We can still choose to file taxes as an S Corp so we get the tax benefit listed above regarding additional profits. (Note: in order to be eligible to do this you have to meet some of the requirements of an S Corp, see the instructions for further explanation.)
Two final lessons learned (very fresh.. we learned them this week... and it involved a last minute dash to the post office)...
- LLC tax returns are due by April 15th. S Corp tax returns are due by March 15th.
- If you are an LLC electing to be taxed as an S Corp you must file Form 2553 (instructions) by March 15th of the year the election is to take effect. Example: to effect your 2016 taxes (to be filed March 15th, 2017), you must file Form 2553 by March 15th, 2016. There are some special circumstances, and there is relief if you miss the deadline (all is covered in the instructions link above).
Resources to Learn More:
- LLC vs. S Corp - Which Business Type is Right for Me?
- LLC Electing S Corp Status -- The Best of Both Worlds
- LCC vs. S Corp
- What business type is right for you?
- Should your business be an LLC or an S Corp?
- A Comparison of the Limited Liability Company and the S-Corporation
Resources in North Carolina to Set Up Your Business: