One of the most important decisions to make when you start a business is what business structure to use, and there are several to choose from in Kentucky. Two common structures are the limited liability company and the Subchapter S corporation. Both forms offer similar liability protection, but have different formation requirements, structures and rules for operation.
An LLC provides tax benefits and flexibility like a sole proprietorship or partnership with the liability protections of a corporation. Profits and losses of the LLC pass through to the LLC’s owners, called members, and those members report the business’s financial information on their personal tax returns. The members are protected from personal liability for the company's debts because the LLC is a separate legal entity from the members as individuals. Generally, LLCs have lower startup costs and less paperwork than corporations since they have to observe fewer formalities.
An S corp is a type of corporation that has elected special tax status from the Internal Revenue Service. Kentucky’s Department of Revenue also recognizes this special tax status, which allows the S corp’s profits and losses to pass through to shareholders and be applied on their personal income tax returns, the same as an LLC. Like other corporations, S corps provide liability protection for their shareholders, but S corporations cannot have more than 100 shareholders. S corps require more legal formalities than LLCs and offer less operational flexibility. For example, like other corporations, S corps are typically governed by a board of directors and operate within specific guidelines set out in their corporate bylaws. Major decisions must be approved by the board rather than one or two members.
Before your business can be recognized as an LLC, you must register it with the Kentucky Secretary of State by filing Articles of Organization. The articles must include details about the business, such as its name and address and the name of its registered agent or representative. Corporations, including S corps, also must file Articles of Incorporation with the Secretary of State. These articles include the corporation’s name and address, addresses of the people who are incorporating the business and the number of shares the corporation can issue. LLCs and S corps also must file annual reports with the Secretary of State.
Various rules and guidelines govern the operations of LLCs and S corps. For example, shareholders in an S corp who work for the corporation must receive reasonable compensation to avoid possible tax consequences. S corps must also hold periodic formal meetings and keep minutes of those meetings. In order to enjoy the pass-through taxation benefits from the IRS, LLCs cannot have more than two of the four characteristics that define corporations: limited liability, continuity of the company when one member dies, centralization of management and free transferability of ownership interests.