How to Incorporate: S Corp or LLC?

By Rob Jennings J.D.

Among small business entities, the limited liability company, or LLC, and Subchapter S corporation, or S corp, are popular structures for their pass-through tax treatment and the limited liability protection they offer their owners -- called "members" in an LLC and "shareholders" in a corporation -- in the event of lawsuits against the company for torts committed by employees or other owners. While they share many similarities, they're not the same thing; an LLC is a special business entity that blends elements of corporations and partnerships, whereas an S corp is a traditional corporation that files taxes under Subchapter S of the Internal Revenue Code.

Step 1

Decide whether you want to organize as an LLC or an S corp. While both offer pass-through taxation and limited liability, as of January 2011, IRS rules do not allow partnerships, corporations or nonresident aliens to be shareholders in an S corp. Such entities can, however, own membership interests in an LLC. Furthermore, while an LLC can theoretically have an unlimited number of members, S corps are restricted to 100 shareholders. S corps, on the other hand, are easier to sell than LLCs. Some states dissolve LLCs upon the death of a member, making it impossible to leave them to your family.

Step 2

Organize your LLC in compliance with state law. Although the specifics of LLC organization varies from state to state, in general you begin by selecting a name for your new entity. After ensuring that your intended name is available in your state and not in use elsewhere, prepare your articles of organization, which contain such vital information about the company as the names of its members, its principal office address, a name and address for a registered agent for service of process, and a brief description of the business purpose for which the company is being organized. File your articles with the secretary of state, secretary of corporations or a similar official in your state capitol, paying the required fee. The fee for registering a new LLC can range from less than $50 to over $500. Draft and execute an operating agreement to govern the internal operations of the company and handle issues such as adding new members, classifying membership interests and returning capital contributions upon dissolution.

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Step 3

Organize a corporation by first selecting a name and then drafting your articles of incorporation, sometimes called a "charter." Your articles of incorporation should contain how many shares of stock are being issued, how many classes of stock you will have -- an S corp can have only one class -- the names of the corporation's organizers and an identification of all corporate officers. Include a description of the company's business purpose. File your articles with the secretary of state or corporations in your state and pay the required fee, which is typically lower than that required for an LLC. Next, execute a shareholder agreement. In accordance with that agreement, hold an initial shareholders' meeting to elect a board of directors and CEO.

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How to Change an S Corporation to an LLC


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How to Dissolve a Corporation & Form a New One

If you are interested in forming a new corporation, you do not necessarily have to dissolve your existing corporation. Even if you have the same shareholders and similar mission, you can have two corporations operating independently. The process for dissolving and incorporating will vary depending on where the corporation is located, as each state has unique requirements. Generally speaking, you must notify the state and pay remaining debts to dissolve a corporation, and a new corporation is formed by filing articles of incorporation with the state.

Subchapter S Corp Restrictions

Most people decide to incorporate their small businesses for the protection it gives them from personal liability for most business debts and obligations. The protection offered by operating a business as a corporation comes at a price. Corporate income is subject to double taxation: once when the corporation pays income taxes, and the second time when the shareholders pay income taxes on dividends they receive. Corporations that meet the restrictions for Subchapter S status can avoid double taxation. Income and losses of a Subchapter S or, as it is more commonly called, an S corporation, are passed through the corporation to the shareholders to be reported on their personal income tax returns, and the shareholders pay individual income tax rates that are lower than corporate rates.

Switching Ownership of the S Corp

An S corporation begins its life as a regular corporation. At some point after creation, the corporation makes a Subchapter S election with the Internal Revenue Service for special tax treatment. To be approved, the corporation must meet the IRS eligibility requirements. S corporations remain subject to the laws of the state as they apply to all corporations, including laws on transfers of ownership. If the change in ownership destroys its IRS eligibility, the corporation will automatically lose its S corporation status.

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