Starting your creative business was your dream and you did it. While there is the excitement of finally starting a business that you are passionate about, there is also the added pressure of making vital business decisions.
One of those decisions is choosing whether to be an S Corp vs. LLC. These terms are thrown around often in the business world and can intimidate anyone unfamiliar with them. Add to it the responsibility of choosing from among them, and the situation becomes even more confusing.
However, the decision becomes easier once you understand what these are and how they differ from each other. Here is everything you need to know before choosing between creating an LLC or an S Corp.
Here are some of the top points of comparison between an S Corp and an LLC.
The first step to deciding between an S Corp and an LLC is to understand what they are.
An LLC or a Limited Liability Company is a business structure that limits the liability of the owners in case the business incurs debts. LLCs are relatively easier to establish and offer a more formal business structure when compared to other businesses, such as a sole proprietorship.
In contrast, an S Corp or Subchapter S Corporation or Small Business Corporation is a tax classification. It is a tax status that tells the Internal Revenue Service that they should tax your business as a partnership and not as a corporation. An S Corp enjoys the limited liability offered to corporations while also avoiding double taxation by the IRS.
The key difference to note is that an S Corp is not a business entity. It is only a tax classification, whereas an LLC is a business entity.
The owners of an LLC are referred to as members. An LLC can have unlimited members, and these members need not necessarily be US citizens or residents. The members of an LLC can also be other businesses. For example, an S Corp or C Corp can be a member of an LLC.
The owners of an S Corp are referred to as shareholders. An S Corp can have a maximum of 100 shareholders. One of the key points while comparing S Corp vs. LLC is that the shareholders of an S Corp must be citizens or permanent residents of the US. Non-residents, non-citizens, and other businesses cannot become shareholders of an S Corp.
An LLC offers flexibility to its members in deciding how to distribute its profits. The members can have an operating agreement that specifies how the profits are shared among them. If all members have contributed monetarily to the LLC, they may decide to share the profits according to each member's contribution.
However, there are cases where a certain member's contribution is their expertise in the business area or property. In such cases, the distribution of profits wouldn't necessarily reflect their monetary contribution.
One of the differences between an S corporation and an LLC is that there is only one class of stock in an S Corp. Each shareholder receives profits depending on the number or percentage of shares they hold in the S Corp.
Both LLCs and S Corps are pass-through entities. The business's profits pass through to the owners and are then taxed at their personal tax rates. If an LLC only has a single owner, the taxation is similar to that of a sole proprietorship.
If the LLC has multiple members, then the LLC uses Form 1065 to file taxes and then gives a Schedule K-1 to each member indicating their share in the profit and their income from the LLC.
S Corps will use Form 1120S to file their taxes.
The business operation of S Corps and LLCs have many differences. An S Corp has a rigid structure for business operations and requires various formalities such as holding annual and initial shareholder meetings, adopting corporate by-laws, keeping a record of the company's minutes of meetings and adhering to all regulations related to issuing shares for the company.
An LLC has more flexibility in this regard. Even though LLCs are urged to follow all the formalities of a corporation, it is not legally binding to do so. LLCs can set up an operating agreement that specifies the formalities that the LLC will follow.
The rigidity and formality of business operations extend to the management structure of an S Corp as well. An S Corp is required to have a board of directors as well as corporate officers such as a CEO and CFO.
The board of directors is responsible for handling major corporate decisions and maintaining a vision for the business, whereas the corporate officers are tasked with managing the day-to-day business activities.
An LLC offers a lot of flexibility in terms of the management structure as well. Owners can either be involved in the running of the LLC themselves or can appoint one or many managers to do so.
The owners of an LLC are considered to be self-employed. They pay themselves quarterly from the profits and pay self-employment taxes on the same. They don't have paychecks or a fixed monthly income.
On the other hand, S Corp owners are considered to be employees. Their salaries also follow the same requirements as that of employees. They receive a regular monthly income and paychecks. Their salaries are paid after the appropriate taxes have been deducted.
The length of existence of an S Corp and an LLC is another key point of difference. The LLC limits not just the liability of the owners but also the duration of its existence. If a member passes away or withdraws from the LLC, it ceases to exist and dissolves.
In contrast, an S Corp can exist forever. The shareholders can transfer their shares to someone else. If one of the shareholders passes away, they can bestow their shares to their heir, who takes their place in the S Corp.
Since the business structure and formalities for establishing an S Corp vs. an LLC vary quite a lot, there are also significant differences in the fees to establish the two. While these fees may vary from state to state, a general idea is given below.
The answer to the question, "Should I make my business an LLC an S Corp?" can vary from business to business. However, it will largely depend on its size and scale.
If you run a small creative business such as an architecture firm or a graphic designing business with a few owners, then remaining an LLC will offer you flexibility in operation. It will let you focus more on the creative aspects of the business without getting bogged down by the technical aspects of running it.
However, if your business has grown and there are multiple owners involved, then the structure provided by an S Corp will benefit you greatly. An S Corp can reduce a lot of confusion and streamline your business operations, helping it grow and reach its true potential.
Are you thinking about becoming an S corporation? Read more to know what it is, how it's different from an LLC, and its pros and cons for your business.
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