But how do you know which business formation to choose? Although some companies choose to become C-Corps, partnerships, or non-profits, for most, it comes down to LLC vs. S-Corp.
Why to Start an LLCYearly, more people start LLCs than S-Corps. When considering the LLC vs. S-Corp question, keep in mind that limited liability companies are a bit easier to start and to run, and generally, they take less upkeep to remain compliant. Some distinct advantages of starting an LLC are:
- LLCs provide liability protection for their members. This means your personal assets will be protected against debts, losses, and any court rulings against your business.
- LLCs are "pass-through entities." This means that dealing with business taxes is much easier, though it also means you'll be paying those taxes on your personal 1040 tax return. That said, you can select to be taxed as a corporation. This brings us to our next point:
- LLCs provide great flexibility. Corporate management structures are far more rigid than those of an LLC. In fact, with an LLC Operating Agreement, you can essentially create the management structure of your choosing.
- LLCs have far less paperwork up front and in the long-term. This makes them easier to run and to keep compliant with state and local laws.
Why to Start an S-CorpThe largest and most profitable companies in America are generally corporations. Keep in mind there are two different kinds of for-profit corporations—S-Corps and C-Corps—and you can read about the differences here.
If you're deciding on an LLC vs. a S-Corp, you should learn some of the major advantages of an S-Corp. Here are a few:
- S-Corps provide liability protection for their shareholders. Only the money invested in the S Corporation by its shareholders is at risk, barring extreme circumstances. Personal assets are usually protected, as they are with LLCs.
- S-Corps are not taxed, but shareholders are. In other words, if you have four partners and your S-Corp made $40,000 this past year, you'll each claim $10,000 in taxable income from your S-Corp. While your S-Corp will need to file an IRS 1120 S form, S-Corps are "pass-through" entities, much like LLCs are, and are not taxed, in and of themselves.
- S-Corps appear more legitimate. Investors often view the corporate structure as more permanent than that of an LLC.
- S-Corps have a more rigid management structure. All S-Corps have hard and fast rules for how to remain compliant, who can vote on corporate practices, etc. These rules give shareholders and owners a real, clear path to follow, and that path is familiar to investors.
- S-Corps require more paperwork. This may seem like a disadvantage, but the additional paperwork actually gives you a concrete record of your decisions and proof that you acted in the best interest of your company. While this can feel tedious, having these documents can be very valuable for tax and liability purposes.
- S-Corps can sell stock. To raise capital, corporations often sell stocks. LLCs can only sell interests in their company.
LLC vs. S-Corp: ConclusionBoth LLCs and S-Corps will give you some measure of personal liability and overall legitimacy. They're both good options if you're looking to upgrade from a sole proprietorship or a partnership, or if you're just starting your business.
But, if you're planning on selling stocks, if you want the most possible protection, and you're planning on looking for investors, think about starting an S-Corp.
Conversely, if you don't want to sell stocks, want less paperwork, but want the most flexibility, consider forming an LLC.
And if you're not sure, visit our Incorporation Center or give us a call. We can answer your questions or point you in the right direction. If you're ready to start your LLC, you can visit our LLC Map to easily find each state's requirements for filing. Conversely, if you'd like more general information about starting a business, be sure to visit or guide.
This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.