An S corporation, or S corp, and a limited liability company, or LLC, are two business entities offering liability protection that people often consider when forming a business in Massachusetts. Both of these business structures restrict the owner's liability to the amount of his investment in the company. There are several differences between the two entities, including how they are formed, how they are taxed and how they must be managed.
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To form an S corporation in Massachusetts, you must first form a C corporation. Forming both a C corporation and an LLC requires that you select a unique business name and file either Articles of Organization or Certificate of Organization with the Secretary of the Commonwealth of Massachusetts. The name of an LLC must contain the words limited liability company, limited company or an abbreviation such as LLC. An S corporation requires no such designation. Once the C corporation has been formed, you can elect for your C corporation to be treated as an S corporation by filing IRS Form 2553, Election by a Small Business Corporation.
In general, the S corp is a more rigid structure than the LLC. For example, the S corp is required to elect at least one officer and one director, create bylaws, hold board meetings and record minutes for those meetings. An S corp is also limited to 100 shareholders. On the other hand, an LLC is managed by members, who are owners of the corporation, similar to partners in a partnership. An LLC can have anywhere from one manager to an infinite number of managers.
An LLC is generally treated as a partnership for tax purposes, but may be treated as a corporation if the LLC exhibits certain characteristics. If an LLC is treated as a corporation, profits will be taxed at the corporate level and again at the member level. If the LLC is treated as a partnership, it will be subject to pass-through taxation, as is the case with an S corp. This means that the entity itself is not taxed and the tax burden is passed on to the shareholders or members. In other words, the entity distributes its profit earnings to the shareholders or members as income and each shareholder or member pays taxes on their individual share. Note that in Massachusetts, an S corp must pay an annual minimum excise tax. Additionally, as of 2012, if the S corp's annual receipts are $6,000,000.00 or more, the S corp may become liable for state income taxes.
Another tax distinction between an S corp and an LLC concerns self-employment taxes. The IRS considers you to be self-employed if you are a member of an LLC. This means that participating members of an LLC are subject to self-employment taxes, which includes Social Security and Medicare taxes. On the other hand, shareholders in an S corp are paid a salary, with their wages reported on a W-2 with Social Security and Medicare taxes already withheld.
Profits and Losses
In an LLC, income and losses are generally allocated to members based on their percent of capital contributed or ownership percentage. However, this can be modified in the operating agreement. On the other hand, the profits and losses of an S corp are always allocated to shareholders based on the amount of shares owned.
As noted earlier, S corps generally have more restrictions than LLCs. An S corp must be a domestic corporation, have no more than 100 shareholders, and have no more than one class of stock. Moreover, certain corporations are prohibited from being S corps, including insurance companies and domestic international sales corporations. One restriction to keep in mind regarding an LLC is that when a member dies or undergoes bankruptcy, the LLC is automatically dissolved, unless an operating agreement provides otherwise; thus, the life of an LLC is limited.