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.

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

In general, it takes pretty egregious acts for a court to waive the corporate shield. Often these acts are committed by closely held corporations, especially ones that are attempting to use the corporate entity as a front for their personal endeavors.

Characteristics Involved

Some of the characteristics that tend to be involved in cases where piercing the corporate veil include:

• Insufficient business capital for what the nature and risks are of said business
• Non-compliance with corporate formality requirements, like issuing stocks and holding required meetings
• Mixing corporate assets with personal business of shareholders
• Fragmenting the business into separate corporations excessively
• Creating a corporation with the sole purpose to avoid existing obligations
• Dominant shareholder siphoning off corporate assets
  

Alter Ego Theory

A term often used in conjunction with piercing the corporate veil is the alter ego theory. This is where the plaintiff’s attorney attempts to extend the reach of liability to additional parties by claiming they were “alter egos” of the primary defendant. These additional entities may be subsidiaries or affiliates of the corporation. By bringing in additional defendants, it can greatly expand shareholders’ personal liability beyond the available corporate assets.

To establish an alter ego claim, generally two elements have to be established. One is proof of a unity or ownership that shows the corporation and shareholder exists, and the other is that there will be inequitable results if these acts are treated as those belonging to the corporation only.

Commingling Funds

Commingling funds, or mixing corporate and personal assets, is one of the most common reasons creditors can pierce the corporate veil. It’s a breach of fiduciary duty and it is a big violation in keeping the corporation a separate legal entity. An example would be when you deposit corporate funds into your personal bank account. Or, when you make withdrawals from your business account to pay personal debts without proper documentation. Other examples would be using the same bank account for both personal and business needs, and moving money back and forth between business and personal accounts without any documentation.

Hiring a Washington DC Business Lawyer

The experienced business law team at Tobin O’Connor Concino P.C. is available to help you with all your Washington D.C. business organization needs. Our specialized team can ensure you learn how to protect your corporation or LLC and reduce your risk from piercing the corporate veil. Contact us at 202-362-5900 and make an appointment to meet with one of our attorneys today.