Minimizing tax obligations and limiting legal liability are among the most important factors to consider in choosing a legal structure for your business. Depending on your particular circumstances, either an "S corporation" or a limited liability company, also called an LLC, may provide the most advantageous structure for your business.
Fit your business needs with the right LLC package
Limited Liability Company
The term "limited liability corporation" is often mistakenly used to refer to an LLC, according to the Free Legal Dictionary. Unlike a corporation, an LLC does not have the legal status of a "person." The individual members of an LLC are considered its owners; LLCs do not issue stock. LLCs file Articles of Organization with the state where the company is located. Although it's not required, an operating agreement determines the distribution of profits and the responsibilities of each member. Businesses such as banks and insurance companies are prohibited from forming LLCs. In some states, a single individual may structure her company as an LLC.
LLC Advantages and Disadvantages
LLCs avoid the "double taxation" of corporations, which pay company taxes and whose stockholders also pay taxes on dividends. The earnings of an LLC pass through directly to its individual members, who pay individual federal and state income taxes. LLCs also provide legal protection for the personal assets of their members against liability for business-related activities. Members of an LLC must pay self-employment tax, according to the IRS. Some states do not allow companies to form LLCs. Other states require the dissolution of an multi-party LLC when one member dies or leaves the company.
A small business corporation, also known as an "S corporation," is one that has obtained Subchapter S status from the IRS. The IRS recognizes S corporations as separate legal entities that pay wages and make distributions to the members. Each S corporation must establish itself as a legal corporation in the state in which it operates, then apply for recognition with the IRS. S corporations schedule board and stockholder meetings and adopt bylaws like conventional corporations.
S Corporation Advantages and Disadvantages
S corporations avoid the double taxation of conventional corporations by not having to pay corporate income taxes. Members of S corporations who work for the company pay individual taxes on their wages, but not self-employment taxes. Stockholders who are not employed by the company pay taxes only on their dividends, which are often taxed at a lower rate than wages. Members of an S-corporation enjoy legal protection for their personal assets against liability for actions related to company business. The IRS places strict limitations on these corporations, which may have only 100 members and issue one type of stock. Partnerships, corporations or individuals who are not legal U. S. residents may not be members of an S corporation, and some states do not recognize S corporation status, while others impose stiff tax liabilities on the earnings of these corporations.
References & Resources
- Business.gov: Should My Company be an LLC, an S-Corp or Both?
- IRS.gov: S Corporations
- Bankrate.com: How to Structure a Small Business
- The Free Dictionary: Limited LIability Company
- Business.gov: Limited Liability Company -- LLC
- Business.gov: S Corporation
- IRS.gov: Instructions for Form 2553
- IRS.gov: Limited Liability Company -- LLC
- IRS.gov: Business Structures
- Business.gov: Business Incorporation