One of the first steps in a business plan is choosing your business entity. With so many different business types and the advantages and disadvantages associated with each one, it can be an overwhelming decision, especially when narrowed down to a limited liability company (LLC) and an S corporation (S corp).
What is an S corporation?
An S corp differs from a C corporation (C corp) in that the corporation is not taxed; the shareholders are. All income is reported on personal tax returns. To reduce exposure to self-employment taxes, shareholders can pay themselves a “normal” salary based on current market rates, while the rest of the revenue is treated as dividends, on which only ordinary income tax applies.
If the shareholders don’t comply, though, the corporation may turn into a traditional C corp.
How the Secretary of State factors in
While most states treat an S corp like the federal government does, some choose to tax the corporation differently, other than taxing the shareholders. Some states do not even have the S corp election available. For this reason, if you are looking into choosing this business type, it is important to conduct a business entity search via the given state’s website to see if you will be taxed differently than the majority of S corp owners. For instance, New York will not just tax the shareholders, but the corporation as well. More can be found on the New York Secretary of State website as well as its taxation and finance department.
How to research business entities
To conduct business entity research quickly and efficiently, go to www.secstates.com. On the homepage, you will have two options, “Find general info on a company” and “Search Secretary of State business databases.”
The first option is a custom corporation search tool, where you can insert entity keywords into the Google search box.
The second option offers a list of all 50 states linked to that state’s specific page and, from there, a link to the secretary of state business page. Once on that specific page, you can either input entity keywords in a search box or click on the specific links, menu options, or categories pertaining to business types. The options will differ depending on the state. For instance, the Secretary of State GA website only displays search boxes to look up the current business name, their business type, principal address, registered agent, and status.
What is a limited liability company?
An LLC is a partnership fused with a corporation. It contains the liability protections of a corporation, but the tax treatment and flexibility that comes with a partnership. Regarding taxation, the members of an LLC, not the company itself, must state the profits and losses on their personal tax returns.
The Secretary of State and LLCs
Like S corporations, some states may treat a limited liability company structure differently. It is up to the state, as this entity can be single or double, or multiple-member, corporate, organization.
On top of that, depending on the specific state, not only will the members’ personal incomes be taxed, but the LLC income as well—even though the government does not see limited liability companies as an individual tax entity.
To find out if the state your prospective LLC would be filed in has any specific requirements, visit the state’s website.
Which business type is best for you?
This, of course, depends on what your needs are and what you aim to accomplish from a business standpoint. If you are a sole proprietor who wants more coverage and protection of your personal assets, an S corporation or limited liability company both provide this benefit.
Both also allow you the ability to deduct pre-tax expenses (i.e. marketing, travel, etc).
In terms of initial expenses, an LLC is cheaper to start than an S corp, and takes less time to form—you may only have to fill out a single document. When it comes to guidelines, an S corp is much more rigid than an LLC, as you must distribute profits fairly across shareholders; the number of shareholder must not exceed 100; and you must be a United States resident and/or citizen. On top of that, shareholders must adhere to regular meetings, keep a record of these meetings (and maintain those records), as well as add, maintain and edit bylaws and stock transfers.
But what you do benefit from with an S corp, versus an LLC, is potentially greater tax benefits. Should your profits exceed your “normal” salary, the excess profits will be broken up, divided, and distributed among shareholders equally; this is not the case with LLC members, who have the option of dividing profits among members as they see fit—a double-edged sword option, so to speak (remember, a limited liability company is part partnership). And for single-member LLCs, you must pay self-employment tax on your income via quarterly installments to the IRS.
Keep this in mind
Of course, when it comes down to these advantages and disadvantages, you must keep in mind what state you intend to register (or convert) your business entity in, as these pros and cons may differ slightly depending on the state. It is best to go to that state’s website for extended research.
Why not combine an LLC with an S Corp?
This is another option. Remember that there are multiple types of LLCs (single-member, two or more individuals…), one of these being an S corp. In this case, the enterprise would remain a limited liability company in the legal sphere, but would be treated like an S Corp for tax purposes.
Since this option may be complex, it is best to discuss this with a knowledgeable attorney and to check out the state’s website as well as speaking to someone from the state’s business sector to fully understand the pros and cons.
Deciding between a limited liability company or an S corporation comes down to what benefits and limitations are more favorable to you—again, check the state’s website to learn more about this information, especially the specific exceptions. In general, most states will treat these entities in the same regards as the federal government, but there are always exceptions.