For many businesspeople, the choice of “business entity” comes down to a choice between the Limited Liability Company (LLC) and S-Corporation.
While quite similar in many respects, LLC’s and S-Corporations both have advantages over one another.
For example, while LLCs and S-Corporations share the same “separate entity” status enjoyed by corporations (meaning the company is a separate entity from its owners), the profits and voting power are not necessarily allotted the same way.
An S-Corporation divides profits between its shareholders evenly. Someone with 30% of the stock would receive 30% of the profits while another with 10% of the stock would receive 10% of the profits, and so on.
This is not the case with the LLC. In an LLC, the members (akin to stockholders, although LLC’s usually issue “member units” as opposed to common stock) decide how profits should be divided. There may be someone with 10% of the “stock”, but they put in 30% of the work. This stockholder can receive more than what they have invested if the other members agree that they deserve it.
The same goes with voting power. S-Corporations follow a more traditional structure by which voting power is determined by stock ownership. An LLC can give more or less voting power to stockholders regardless of how much stock they may own.
Also, there are several other abilities an LLC has that do not apply to S-Corporations.
- No ownership restrictions – virtually anyone (individuals, Corporations, other LLC’s, and even foreign entities may be owners of an LLC).
- Can operate with a single member.
- Are not required to hold annual meetings.
An S-Corporation has separate ownership provisions. The S-Corporation is limited to 75 shareholders all of which are required to be US citizens. They are also required to hold shareholder and corporate meetings, which can affect record-keeping needs and continuity within a company.
LLCs sound pretty good, right?
Well (and you knew this was coming), there are some down-sides too.
For starters, S-Corporations get better deductions in regards to benefits (health insurance, etc.)
The status of the pass through income is a little different as well for the personal service principals (the principals that are employees.) It is considered “passive income” and not “earned income (like it is with an LLC.) Thus, Social Security and Medicare taxes (at this writing) are not levied.
In addition, LLC’s may have a limited shelf-life. Some states have a cap on how long they can stay in business (30 years, etc.)
In closing, you could say that S-Corporations allow for more shareholder uniformity and tax savings, while an LLC allows more free negotiations and possibilities for ownership and accountability. You can almost think of an LLC as a marriage between a classic small business (partnership / sole proprietorship) and a corporation.