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Should I Choose an LLC or S-Corp?

One question I am often asked is what is the difference between a S-Corporation (a corporation that elects to be taxed as a partnership, otherwise known as S-Corp) and a LLC? There are a few major differences that may be able to help you select the appropriate entity for your business. Please remember that this advice is for people starting businesses in Texas only.

1. Taxation. Both LLCs and S-corps receive "pass-through tax status," meaning the entities are not taxed at a corporate level, and, any payment made to an owner (except as described in this paragraph) is subject to self-employment tax and federal income tax. However, an S-Corp, since it is a type of corporation, also has distributions to shareholders (the owners of the S-Corp). These distributions are not subject to self-employment tax. For example, say a group of owners open up a widget store in Texas as "Widget Store, S-Corp." The owners must pay themselves a "reasonable salary," and, on top of that, may distribute funds to themselves as a shareholder distribution. There are other caveats to the ability to receive distributions in this tax-free manner other than the reasonable salary requirement, one of which is every owner receiving salary and distributions must be involved in day-to-day operations. Paying themselves in this way lowers the tax liability of the owners because each owner will not pay self-employment tax on distributions, but only Federal income tax. This is not possible with a LLC. In a LLC, each owner will pay self-employment taxes (as of the date of this article, 15.3%) and Federal income tax on all money received from the business.

2. Types of Ownership. Any person and/or entity may own an LLC, and the number of owners allowed is unlimited. This flexibility of ownership allows an LLC to have any person or any type of business to become an investor in the company, which in turn makes it easier to raise capital or bring in outside investors. Also, the ability for any person or entity to own an LLC relieves the possibility of losing LLC status for incorrect ownership. A S-Corp, on the other hand, has many more restrictions on ownership, and if the restrictions are not adhered to, the corporation loses its S-Corp status, and will owe the corporate tax rate (as of the date of this article, 35%) on gross revenue of the corporation. These rules include having less than 100 shareholders, and no other type of entity, including other corporations, LLCs, and partnerships, may own shares in a S-Corp, save for a few exceptions. The restrictions on ownership makes it much more difficult for an S-Corp to approach outside investors for capital or any other type of investment, as the investors may not be able to own part of a S-Corp.

3. Company/Corporate Structure. LLCs are much more fluid in their company structure. There are "members" and sometimes "managers" or "managing members." Unless stated otherwise in the LLCs operating agreement, any member of the LLC can transact business for the LLC. The simple structure of LLCs is much easier for most people to adhere to and grasp as a newly minted business. A S-Corp, on the contrary, has a much more rigid corporate structure, and must be managed in that manner to help prevent any "piercing the corporate veil" (see article here addressing the topic) issues. There must be a board of directors, and at least a President/Ceo, Vice President, and Secretary. Each officer does not have the same abilities to transact business. A person can serve in more than one position at the same time, however, as a practical matter, the formalities of the S-Corp must be upheld to keep the corporation's legitimacy intact, in both the legal and practical world.

Although there are other differences between the two types of entities, these are the most glaring. If you are thinking of incorporating your business (which you should, since it relieves personal liability for company or corporate debts), you should consult with your local business attorney.

--Charlton M. Messer, Esq.

This article is intended for informational purposes only.

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