You may need to compare an LLC and a Subchapter S Corporation when deciding on the best legal structure for your business. This comparison is complex, and your final decision should be based on a thorough analysis of the tax consequences of your decision, as well as the costs to create and maintain the new legal structure for your business. In addition to your own efforts, the services of an accountant, lawyer or other business professional may be required to adequately make the comparison in light of your business needs.
Fit your business needs with the right LLC package
Research the cost to form an LLC and a corporation in your state. For purposes of state law, the formation requirements for an S Corporation are identical to a traditional or C Corporation. The costs include such things as filing fees, publications fees, business license fees and franchise tax fees. The difference between the two can be significant. For example, in New York, the 2011 filing fee required by the Department of State to form an LLC and a corporation are similar -- $200 and $125, respectively; however, the formation of an LLC also has a publication requirement that does not apply to forming a corporation. Publication costs are estimated to be anywhere from $300 to $1,600, depending on the county where your principal address is located.
Research the yearly cost to maintain an LLC or corporation in your state. Such costs typically include an annual or biennial information filing which includes a nominal fee. Costs can also include a yearly franchise tax fee. In California, the franchise tax fee for both LLCs and S Corporations is $800; however, an S corporation is also taxed on its net income, while an LLC may be subject to an additional fee based on its total income from all sources. The impact of these taxes or fees on your business will depend on its total income and available deductions, and can affect its net income.
Prepare a tax analysis of how you plan to distribute the income from your business. Include whether you will be taking on ongoing reasonable salary and paying employment taxes -- as can be done with an S Corporation -- or taking a distribution of profits throughout the year and paying self-employment tax -- as is done with an LLC. The tax consequences for each are different depending on your circumstances. Also consider your business’s anticipated cash flow to determine whether you can commit to paying ongoing employment taxes in a timely manner.
Tips & Warnings
Because an LLC can elect its tax treatment for federal tax purposes, you can form an LLC and elect to be treated as an S Corporation. Depending on your business situation, this may provide you with certain tax advantages available to an S Corporation that is not available to an LLC that is taxed as a partnership or sole proprietorship.
Once you form either an LLC or S Corporation, there will be tax consequences based on how you run your business. Although you can convert your business from one form to another, it will invariably cost more than setting it up right in the first place, and you will still have to pay taxes based on your initial formation decision. It is prudent to obtain professional advice before choosing your business structure, and it is usually more cost-effective than correcting a mistake.
References & Resources
- New York Department of State: Corporate Fee Schedule
- New York Department of State: Limited Liability Company Fee Schedule
- Minutes Magazine: New York’s Irrational LLC Publication Requirements
- California Franchise Tax Board: Limited Liability Company (LLC)
- California Franchise Tax Board: S Corporation
- IRS.gov: S Corporation Compensation and Medical Insurance Issues
- Business.gov: Limited Liability Company (LLC)
- Business.gov: S Corporation
- IRS.gov: Limited Liability Company (LLC)
- IRS.gov: S Corporations