If you’re like most people, you’re probably not sure where to begin when it comes to choosing which type of business you should form. Chances are you’ve been advised at one point or another to form either an LLC or an S Corp, and you might not know just what those terms mean or how those two business structures differ.
LLCs and S Corps are similar in some ways. They both offer you, as the business owner, limited liability protection, meaning that your personal assets typically can’t be touched to satisfy business liabilities and debts. Both entity types also provide certain favorable tax treatment over other corporate entity types.
So, what are the differences? There are several, largely relating to ownership, management, and business formalities, that can impact which form is right for your business.
Ownership
There are no limitations on who can be an owner of your LLC. Specifically, with an LLC:
- There can be an unlimited number of owners or members;
- The owners do not need to be U.S. citizens or residents;
- The owner can be another business entity.
The same is not the case for S Corps. The IRS places a lot of restrictions on an S corp when it comes to ownership. It can have no more than 100 owners (shareholders), none of the owners can be non-U.S. citizens or residents, and the S Corp cannot be owned by another business entities like C Corps, LLCs, partnerships, or other S corps.
Classes of Stock and Voting Rights
Unlike some other types of business entities, S Corps are only permitted by the IRS to issue one class of stock. This means that can’t give voting rights to certain investors but not others. Normally, corporations can opt to issue preferred stock, which has voting rights, to some investors, and common stock, without voting rights, to others. If you try to do that as an S corp, it can result in severe tax consequences on both your business and personal tax returns. The same is true if there are any differences in the shares issued to your investors.
LLCs, in contrast, don’t issue stock at all. An LLC is owned by its members, whose rights are spelled out in their membership agreements. As members are added to an LLC, the rights and ownership of each can vary. Unlike an S Corp, you can limit which owners of the company have the right to vote on company decisions.
Management
An LLC can opt to have the LLC managed either by the owners/members or managers. A member-managed LLC will more resemble a partnership in how it functions, while a manager-managed LLC functions more like a corporation, wherein an elected individual is the one making the business decisions. (Both structures have pros and cons, and choosing which is best for you is very specific to your specific situation). An S- Corp, on the other hand, is required to have directors and officers. The designated directors manage the overall business affairs, while elected officers handle the daily operations.
Business Formalities
While all businesses must inevitably deal with plenty of formalities, the required formalities are typically greater for S Corps. While it’s recommended that LLCs follow certain procedures, they’re generally not required to do so.
For example, S Corps are required to adopt bylaws, authorize and issue stock, hold annual director and shareholder meetings, and document those meetings with formal meeting minutes. While LLCs may choose to do any or all of those things, they don’t have to do any of them.
Although LLCs have many advantages over S Corps, many people like the fact that the tax treatment of S-C Corps allows you to pay yourself a salary and distributions of company profits throughout the year without paying as much in self employment taxes. The good news, though, is that, even if you opt to form an LLC, you can still elect to be taxed as an S Corp by filing paperwork with the IRS.
There’s no one-size-fits-all answer to which entity type is right for a small business. When it comes to NY LLC formation, you need to keep in mind the specific needs and circumstances of your individual company. After all, your company is unique, so what works for someone else might not work for you. It is important to work with an experienced lawyer to choose the entity that makes most sense for your specific situation.
Legal Guidance in Building Your Business
At Gouchev Law we work with businesses of all sizes, including start-ups and franchises. Call us at (212) 537-9209 or schedule a strategy session today to see what Gouchev Law can do for your business.