S Corporations and LLC’s are similar in many ways, but there are differences that can affect your business. In order to make the best incorporation decision it helps to be well-informed of the pros and cons of both business types.
How S Corporations and LLC’s are Similar
State filings recognize both business types as separate legal entities. This means that the business owner and the business are not one and the same; the business is considered an individual “being,” or entity. There are mandatory business formalities, which includes fee payments and filing annual reports. Business owners are not responsible for any debts and obligations collected by the business. Both corporations and LLC’s are pass-through taxation business types, which mean business income is considered the business owner’s or investor’s income. Income tax, any loss or profit, and any other business taxes are reported and paid on a personal, business owner’s level. Business tax returns must be filed by S Corps, while LLC’s do so only if there is more than one owner.
How they are Different
The IRS places certain requirements on business entities such as a limit to the number of owners an S Corp can have; S Corps cannot have more than 100 owners, also known as shareholders. If IRS ownership restrictions are met, S Corp stock becomes freely transferable. There is no ownership limit placed on LLC’s. Approval from other LLC members is necessary to make LLC membership interest (ownership) freely transferable.
An S Corp consists of directors and officers where corporate affairs and major decisions are handled by a Board of Directors. It is the Board of Directors that elects the officers who are to be responsible for the day to day business operations. The shareholders must be U.S. citizens/residents. S Corp owners are treated like employees, paid reasonable salaries, so FICA taxes are withheld and paid on that amount. S Corps cannot be owned by the following entities: other S Corps, C Corps, LLC’s, partnerships or trusts. The length of existence can be perpetual.
There are many formalities that an S Corp must continuously carry out. This includes (and is not limited to): adopting bylaws, initial and annual meetings (for directors and shareholders), issuing stock and recording meeting minutes.
Within an LLC the owners decide if they themselves, the members, want to manage the entity or elect managers to do so. It is like a partnership when the members manage the LLC, but if it were the managers running the LLC then the LLC is more like a corporation. LLC’s can have non-U.S. citizen/resident members. LLC’s are allowed unrestricted subsidiaries.
Some formalities that LLC’s must carry out include: documenting important company decisions and annual meetings, issuing membership shares and an operating agreement. Some states require including a dissolution date in the formation documents. The death or withdrawal of a member can also cause an LLC to dissolve.
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