So you’re in the planning stages of your new business venture…
Or maybe you’ve been operating for awhile but just hadn’t gotten around to doing the “business” paperwork…
Chances are your CPA has reminded you that no job is finished until the paperwork is done and you know it’s time to make your business structure official.
Depending on the nature of your business, you’ve probably been given the option of a Subchapter S Corporation (an “S Corp) or a limited liability company (LLC).
Which one do you choose?
It helps to know the pros and cons of each option so here’s a brief breakdown of the advantages and disadvantages of both:
Subchapter S Corporations
A Subchapter S Corporation is a tax election which means that you’re telling the IRS how you want your company to be treated for taxation purposes. An S Corp election lets you as the shareholder treat profits and earnings as distributions and pass them through to your personal tax return.
If your company turns a profit and you’re an employee of the company, you have to pay yourself a salary and your salary must be “reasonable” – basically what you would pay someone else to do your job. If you don’t pay yourself a salary, the IRS can reclassify the company’s profits as wages and you personally get to pay the payroll taxes on the full amount.
Some Advantages of the Subchapter S Corporation
- The life of the company is not bound to you. If you die or become incapacitated, the company can continue on without your involvement.
- The gifting, purchase or sale of stock makes it possible to change ownership of the company without disrupting the business.
- With a few exceptions, if your Subchapter S Corporation is a partnership, the corporation pays no income taxes and corporate income or loss is passed through to the stockholders. You are not personally responsible for it.
- If your S Corp has a strong business record, it’s usually easier to access credit and the secure resources as needed.
- The corporation’s finances are required to be maintained separately from the stockholders so there is less risk of unrecognized equity liquidations that could disrupt your business.
Some Disadvantages of Subchapter S Corps
- Disagreements among stockholders may disrupt the decision making process.
- If your bylaws include restrictions on the sale or buy-back of stock, minority stockholders may not be able to recover the value of their investment in the company.
- If stockholders give stock to their heirs, the stock ownership of the company may end up in the hands of people who are not actively involved in the business and that can lead to problems for the managing stockholders if they don’t cooperate.
- If your company owns assets that appreciate and you dissolve the company, you will have to pay income tax on the appreciation amount.
If you would prefer a simpler corporate structure, you might consider forming a limited liability company (“LLC”). LLC’s are relatively new and were designed to limit personal liability of the owner, much like a corporation, but give the operating efficiency of a partnership.
An LLC is not a separate tax entity. The IRS considers an LLC to be a pass-through entity like a sole proprietorship. All the profits or losses of your LLC pass directly to you and you claim them on your personal tax return.
Some Advantages of the LLC
- You have limited personal liability for actions of the LLC.
- You have a lot of flexibility in how your profits are distributed.
- You don’t have to have corporate meetings, keep minutes or even pass resolutions approving the actions of the company.
- Your business losses, profits and expenses flow through to the individual members of the LLC.’
- You only pay individual taxes, not corporate and individual taxes.
Some Disadvantages of the LLC
- The LLC must be dissolved when a member dies or declares bankruptcy.
- You cannot issue stock in your LLC so you can never take it public without changing the corporate structure.
- You will have more paperwork in an LLC than a sole-proprietorship; however, your LLC may be classified by the IRS as a sole-proprietorship, partnership or a corporation for taxation.
There are advantages and disadvantages to either structure. The choice is yours. You know your situation and your goals for your company better than anyone else.
Just make sure you talk to an attorney well versed in corporate formations before you make the final decision. This was just a quick list of the pros and cons of both corporate structures. There are many other aspects to take into account before you sign on the dotted line.
The Parents Estate Planning Law Firm, PC
Latest posts by The Parents Estate Planning Law Firm, PC (see all)
- CONSIDER THIS BEFORE YOU CREATE A WILL ONLINE - March 16, 2023
