For many startup owners and entrepreneurs, following their passion by building their own business was at least in part a way to avoid cubicle life, spreadsheets, and generally uninteresting issues of corporate finance and compliance. But as your business grows, these types of issues can have a huge impact on your bottom line, your potential liability, and how much of your profits you will get to keep at the end of the year. One of these issues is deciding whether you want your business to be formed as an LLC or an S-Corp. Below we take a look at some of the similarities and differences these formation choices offer.
What an LLC and S-Corp Have in Common
First off, an LLC and S-Corp are by no means the only options you have in forming your business, either in New York or elsewhere. For example, you can form a sole proprietorship, general partnership, or limited partnership, among other options.
The advantage an LLC or S-Corp offers over those types of entities, however, is that of limited liability, which means that an owner will only be liable to the extent of his or her investment in the business. Thus, if you have a $200,000 ownership stake in an S-Corp or LLC, and the business is liable on a $1,000,000 debt, then you will only be liable for the $200,000 you have invested. However, with the aforementioned entities, you could personally be liable for the entire $1,000,000.
What makes an LLC or S-Corp preferable to a general business corporation is that profits on an LLC or S-Corp will “pass through” tax-free to the owners (at least at the federal level), who will then pay the taxes on their individual distributions. This is unlike a business corporation where the corporation itself must pay corporate taxes and then the individual owners will then pay taxes on the distributions they receive, resulting in so-called “double taxation.” Note, however, individual states and cities (e.g. New York and New York City) may impose additional taxes.
The Relative Advantages of an LLC and S-Corp
The primary advantage of an S-Corp over an LLC is that an S-Corp may provide significant tax advantages to its owners. With an S-Corp, the owners can choose to pay themselves a “reasonable salary” which is taxed at ordinary income tax rates, but then receive all excess profits at the dividend tax rate, which is generally lower than the rate applied to ordinary income. With an LLC, however, you will be required to report all annual profits in your personal income tax return.
LLCs, on the other hand, generally require less paperwork and regulatory requirements than S-Corps and more businesses are eligible to be LLCs than S-Corps. LLCs can be relatively easier and more inexpensive to form than S-Corps, and, if you are the only owner of an LLC, you are not required to file a separate tax return for the LLC in addition to your own tax return. Depending on your state’s business law rules, S-Corps may require your business to adhere to additional compliance regulations such as regular shareholder meetings, which would not apply to an LLC.
Because every business is different, and because state and local law may impose additional requirements and/or provide benefits based on your selection as an LLC or S-Corp, it is important to work with an experienced business law attorney to determine which formation option is best for your business.
Legal Guidance in Building Your Business
At The Gouchev Law Firm in New York, we work with businesses of all sizes, including start-ups and franchise businesses. Call us at (212) 537-9209 or schedule a free strategy session today to see what The Gouchev Law Firm can do for your business.