Jul 02 2013

S-Corporation vs. Limited Liability Company

For the small business owner or partnership the purpose of forming either a S-Corporation “S-Corp” or Limited Liability Company “LLC” is to create a barrier of financial protection between the actions of the company and the owners of the company. In doing so if the company gets sued or goes into bankruptcy the owners of the company are not personally liable, or in other words, the owners will not loose any more than what was placed into the company; assuming that there is not a piercing of the corporate veil.

Should I form an S-Corporation?

S-Corporation is designed to be used for small, closely held, corporations that do not intend to have more than 100 shareholders. All existing shareholders must be United States Citizens or permanent residents. S-corporations are only allowed to have one class of stocks, so there is no common and preferred stock just voting and non-voting stock.

S-Corporation is as equally formal as a C-Corporation. They must have a board of directors, hold and record board meetings, as well as record corporate minutes.  Changing a S-Corporation’s structure or making major business decisions requires a board meeting to be held so that board members may vote on the decision at hand. Shareholders that hold a voting stock elect the board members, which then vote on decisions of the corporation.

S-Corporations are known as pass through companies, which means that the profits are passed on to the shareholders though dividends. So the company does not pay taxes on its profits, but the shareholders pay taxes on the company’s profits in their personal income taxes. Conversely this also means that the company’s losses can be passed to its shareholders personal taxes.

S-Corporations and LLCs both require that funds be kept separate from those of the members or shareholders in order to receive the legal protection of being a S-corporation or LLC.

Should I form an LLC?

LLCs are created for the purpose of protecting it members. Members are the owners of the LLC and are typically share equal ownership in the LLC, unless apportioned other wise. The idea that members of a LLC are equal owners does not mean that each member must receive equal portions of the profit. For example, if one member does most of the work while the other member is primarily acting as an investor, then allocation of the profits could be 75% for the working member and 25% for the investing member. This type of decision should be agreed upon by both parties. This varies from a S-corporation in that shareholders own a percentage of the company based on the amount of shares they own and how many shares are outstanding.

Typically each member shares in the day-to-day responsibility of running the business; this is called a Member-managed LLC. Another option form of an LLC is a Manager-managed LLC. A Member-managed LLC is when a manager is chosen to manage the company. This option is often used when there are many members and it is not feasible to have all of the members attempting to manage the day-to-day operations or when an LLC might have passive investors as members. When choosing a Member-managed LLC it must be clearly stated in the formation, as well as it’s a good idea to write out the powers and obligations that the Managing member will have.

LLCs are considered to be much less formal than S-Corps because there is not a separate level of management. This separate level of management, in an s-corp., can add to many more costs such as legal fees, board member costs, filing of the corporate minutes, etc. Most small businesses simply do not need a separate level of management. Since a LLC is not as formal its structure can be changed at any time, whereas an S-Corp. must have a formal board meeting in order to change its structure.

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