Forming a separate legal entity for your business should accomplish at least two goals: shield your personal property from business debts and reduce your tax liabilities to the lowest lawful amount. For many small businesses, the legal entity of choice is usually a limited liability company or S corporation. Maryland, as all other states, allows business owners to form either of these legal entities. Comparing an LLC and S corporation with the needs of your business is essential to determining which legal entity is right for you.
LLC Formation Requirements
To form an LLC in Maryland requires filing a document called "articles of organization" with the Maryland State Department of Assessments and Taxation. After filing, the LLC comes into existence and the owners of the LLC are referred to as "members." The department website provides a form template of the articles of organization that you can fill out online and then print out and sign before mailing it with a fee to the Maryland State Department of Assessments and Taxation.
S Corporation Formation Requirements
Maryland business owners incorporate their business by filing a document called "articles of incorporation" with the Maryland State Department of Assessments and Taxation. This is the first step regardless of whether you want to form an S corporation or C corporation. As with an LLC, the corporation comes into existence after the articles are filed with the department; the owners are referred to as "shareholders." The department website also provides a template form of the articles that you can fill out online and then print out, sign and mail with a fee to the Maryland State Department of Assessments and Taxation. However, when you file the articles of incorporation, the corporation is considered a C corporation, not an S corporation, until you file Form 2553 with the IRS, commonly known as a “Subchapter S Election.”
Ownership Rules Comparison
IRS rules include strict shareholder qualifications for an S corporation. An S corporation cannot have more than 100 shareholders and can only issue one class of stock. An S corporation’s shareholders cannot include non-resident aliens, other corporations or partnerships. Violating any of the rules will result in the IRS taxing the S corporation as a C corporation. By contrast, LLC members are not subject to these restrictions and can have any number of members. The LLC members can be individuals or other legal entities, such as a corporation or limited partnership. An LLC can also have as many subdivisions as it needs. However, an LLC cannot issue any stock; it can only offer potential investor ownership interest in the company.
Income Tax Comparison
The primary reason for making a Subchapter S election is to avoid the “double taxation” problem involving a C corporation's profits; that is, a C corporation first pays taxes on its profits and, after paying the remaining profits to the shareholders as dividends, the shareholders pay tax on the dividends. By contrast, an S corporation is treated as a partnership for income tax purpose, whose profits flow through to the owners and are not taxed at the partnership level. Likewise, an S corporation's profits flow through to the shareholders and are not taxed at the corporate level. An LLC is not a recognized legal entity under the Internal Revenue Code, which gives an LLC more income tax options than an S corporation. The LLC members have the option of choosing the LLC's tax treatment either as a partnership, corporation or, if there is only one member, as a sole proprietorship. The LLC files Form 8832 with the IRS to select an entity classification for income tax purposes. If the LLC chooses to be taxed as a corporation, it also has the option of making a subchapter S election. For a single-member LLC, this may be a desirable option because it avoids the self-employment tax problems typically encountered by sole proprietors.
Management and Organizational Structure Comparison
Maryland law specifies the management and organizational requirements for an LLC and S corporation, which may be the most significant difference between the two entities. Like all Maryland corporations, an S corporation must follow a rather rigid organizational structure that requires adopting bylaws, holding an annual shareholders meeting, electing a board of directors, and appointing a president, secretary and treasurer. By contrast, Maryland law does not impose any of these requirements on an LLC. Members have the flexibility to organize the LLC management as they see fit. The members of an LLC can opt to have all members manage the LLC or designate one or more members to act as manager, including designation of a non-member. However, it is possible to form a single-member LLC, as well as a single-shareholder S corp.