You may consider exploring a new type of business organization in order to protect personal assets and/or benefit from potential tax breaks. Some business owners find themselves torn between an LLC and S corporation. Without a clear understanding of how each business organization structure works, you cannot make an informed choice.

If you’re debating on setting up a new business, it’s important to speak with a skilled Washington DC business attorney who can share their expertise and help you choose a business structure that’s right for you.

Here’s a look at a few similarities and differences between LLCs and S corporations.

How LLCs and S Corporations are Similar

Both LLCs and S Corporations provide some personal liability protections. In most cases, your personal assets cannot be attacked by company creditors. Essentially, you can’t be held liable for more than your investment in the company itself. Unless there is proof of something that can “pierce the corporate veil,” like commingling personal funds with business accounts, then your personal assets should be protected.

Both types of business structures are treated as pass-through tax entities. This means the business does not pay income tax at the company level. Income and losses are passed through to the owners and shareholders who report them on their personal tax returns. This avoids the common “double taxation” issue traditional corporations are subject to.

How S Corporations and LLCs Differ

One of the most important ways LLCs and S corporations differ is in their ownership requirements. The IRS has established very strict regulations regarding S corporation ownership. Not every business who wants to be an S corporation will qualify. For example, if you have more than 100 shareholders, you won’t qualify. Do you have fewer than 100 shareholders but one of them is a non-US citizen or another corporation? You won’t qualify either. LLCs are not subject to the same strict rules required to elect S corporation status.

Management of an LLC is more relaxed and flexible as well. Owners, who are called members in an LLC, can opt to manage the LLC (member-managed) or appoint a manager (manager-managed). S corporations must have a board of directors and elected officers. LLCs also don’t have the strict rules regarding record keeping of meetings.

Another major difference is that an S corporation is essentially in existence forever. Corporations can exist in perpetuity, which is very different from LLCs. If a member decides to depart, it could result in dissolution of the LLC.

Making the Decision

There is no “one model fits all” for business owners. It’s important to weigh all the pros and cons and learn more about how LLCs and S corporations are required to operate. If you are looking to set up a new business, contact the attorneys at Tobin O’Connor Concino P.C.. Let one of our skilled Washington DC business law attorneys help with all your potential LLC and corporation needs.

C Corporation vs. S Corporation

When you incorporate, the default corporation type is the traditional C corp. Becoming an S corporation is a special election done through the IRS and is subject to strict guidelines. Not everyone will be eligible for S corporation status.

Both have some similarities in the way they handle ownership, liability, capital, and governance. And, they are both corporations, just one is a separate status that applies to some variations in taxation and ownership.

Similarities Between C and S Corporations

At the end of the day, there are probably more similarities than differences when you compare the two corporation types. The following attributes are found in both S and C corporations:

• Corporate Structure: Corporations have a specific structure that must be followed with shareholders, officers, and directors. Directors handle major decisions and elect officers who handle the day-to-day operations. Shareholders are the owners who elect the board of directors.
• Liability: In general, shareholders are not personally liable for the company’s debts and liabilities. However, there are certain circumstances that can open the door for personal liability if the corporation doesn’t operate in compliance with regulations.
• Compliance: Both corporation types are expected to file certain documents with their governing state, like the Articles of Incorporation. There are other similar activities like stock issuance, enacting bylaws, holding director and shareholder meetings, and more.

Differences Between S and C Corporations

The biggest differences between a traditional C corporation and an S corporation revolve around ownership and taxation:

• Ownership: C corporations have no cap on the number of allowed shareholders, whereas S corporations are capped at 100, and all of them must be US citizens. S corporations cannot have other corporations, LLCs, or trusts as shareholders whereas C corporations can. S corporations are also limited to the type of shareholders they have. C corporations can have different levels of shareholders where votes can count with different weighting. S corporations are restricted to one type of stock only.
• Taxation: For both corporation types, shareholders pay personal income tax on dividends and from salaries drawn from the corporation. The big difference here is C corporations are also taxed at the corporate level. S corporations are treated like pass-through entities, thereby eliminating the “double taxation” issue often noted with C corporations.

Determining Which Type of Corporation is Right for You

Once again, there is not one corporation type that works best for all businesses. It really comes down to your long-term business goals, among other things. If you’re preparing to incorporate, contact the attorneys at Tobin O’Connor Concino P.C. to schedule a consultation. Let one of our skilled business organization attorneys help you decide which business organization type is best for you.

S corporations are named after Subchapter S of the Internal Revenue Code. An S corporation is a business that has decided to “pass through” their profit and losses to shareholders for federal tax purposes. That means all income, losses, credits, and deductions are claimed by individual shareholders rather than taxed at the corporate level. The S corporation is desirable because it eliminates the issue of double taxation.

Qualifications to Become an S Corporation

There are rather strict qualifications you have to meet before you can consider electing S corporation status. To start, you must incorporate first as a traditional C corporation. Then you must meet the following requirements as set forth by the IRS:

• Only domestic corporations can be an S corporation — no international or foreign-owned companies
• Shareholders can only be U.S. citizens or residents
• Shareholders can only be individual people, plus some trusts and estates as well — they cannot be other corporations or partnerships
• You are allowed a maximum of 100 shareholders
• Only one class of stock is allowed
• You cannot belong to a corporation that is declared ineligible —insurance companies, domestic international sales corporations, or certain financial institutions

How to File for S Corporation Status

If you meet the qualifications set forth above, you have to file for S Corporation status by completing Form 2553 Election by a Small Business Corporation to the IRS. It must be signed by all shareholders.

Then, you need to make sure you understand what tax forms are required as an S corporation. For example, although federal taxes are paid at the individual shareholder level, S corporations need to file IRS Form 1120S which is primarily for informational purposes so the government knows how much taxes they should be expecting from each person. Shareholder profit, losses, and deductions are noted on Schedule K-1 so everyone knows what numbers to use for their personal returns.

Advantages and Disadvantages

As with any business type, there are advantages and disadvantages. Avoiding double taxation is obviously one of the main advantages. However, not all S corporations can benefit 100% from the double taxation benefit. If you do business in multiple states, be aware of local tax laws. For example, California levies a franchise tax on all S corporations.

Liability protection is another desirable aspect of S corporations. Creditors can make no claim on personal assets of shareholders in hopes of settling business debts. This is different from sole proprietorships and partnerships that are at risk when a business debt arises.

If you don’t follow the rules exactly, you can be labeled noncompliant and the IRS will strip your business of its S corporation status. It’s important to keep detailed records and do all your accounting so you don’t risk losing status.

There are other advantages and disadvantages to S corporation status. However, the decision to elect S corporation status is entirely personal and what works for one small business may not work for another. If you’re contemplating filing an S corporation, it’s important to meet with a skilled Washington DC business attorney who has experience with S corporations. Contact our team at Tobin O’Connor Concino P.C. to schedule a consultation and let one of our knowledgeable attorneys help you choose the right business organization for your company.

Resource:

irs.gov/businesses/small-businesses-self-employed/s-corporations