One of the first questions facing you as a small business owner is to decide what type of entity you want to create — stay as a sole proprietor or form an LLC or a corporation. Once you have done that the question is whether to file with the IRS as an S corp. For some businesses, particularly very small or low risk businesses it may be okay to stay as a solo. In most cases it is not.
An LLC (Limited Liability Company) is a business structure that combines the pass-through taxation of a partnership or sole proprietorship with the limited liability of a corporation. As a member of an LLC, the profit goes directly to you, you are not paying yourself a salary.
An S Corp is a corporation business structure that issues stock and is governed as a corporation. IT IS NOT AS MANY THINK AN ACTUAL TYPE OF CORPORATION. It is a tax election status. The owners are called shareholders and have the same protection from liability as shareholders of a C Corp. An LLC and a C Corporation can each file under S Corp tax election. However, like a sole proprietorship or partnership, an S Corp passes through most of its income and loss items to shareholders. Unlike a regular corporation, there is no double taxation (once at the corporate level and again at the individual shareholder level). Each shareholder is subject to his or her own individual tax rate on the income or losses passed through to him or her. A big plus of either entity is that if structured and operated properly you can protect your other assets from claims against the business.
So how do you know which entity is right for you? Let's take a look at a few more differences between each of the entities.
- Filing Cost — It is generally about the same cost to file to form an LLC and S Corp license.
- Tax Consequences — Tax consequences depend upon the income of the business, of course, but in general, each business entity has about the same personal and business tax expenses.
- Self-Employment Taxes — An S. Corp can provide savings on self-employment or Social Security and Medicare taxes. It also allows owners to offset non-business income with losses from the business.
- Ownership Restrictions — An LLC has no restrictions on the number of owners the business can have. An S Corp can have no more than 100 owners and owners cannot be “non-resident aliens.” S Corps cannot be owned by C Corps, LLCs, and other S Corps or by some non-qualified trusts.
- Business Losses — The S Corp allows business owners to use business losses on their personal tax returns.
- Paperwork — an S Corp does require more upkeep in the form of annual paperwork and ongoing tax filing responsibilities than does an LLC.
For questions specific to your particular situation, it is best to seek the advice of an attorney and CPA to help you make the best decision for your business model.