WHAT IS THE DIFFERENCE? S-CORPORATIONS VS LIMITED LIABILITY COMPANIES
You’re getting ready to get your business off the ground and you can’t seem to get a straight answer: should you form your business as an S-Corporation or Limited Liability Company (LLC)?
To start with, both of these choices have similarities. Both an LLC and an S-Corporation give you the “corporate veil protection” that is so important. This means that if the entity is formed and utilized correctly, your personal assets will be protected in the event of a lawsuit. Another similarity (and advantage as compared to a normal corporation) is that neither of these entities pays any federal income tax. All profits and losses are “passed through” to the owners’ tax returns where it is recognized at that level.
What are the main differences between these two choices? S-Corporations follow corporate tax law. LLCs follow partnership tax law. What does that mean? Partnership tax law favors certain types of businesses. If your new venture is going to own appreciating property (i.e., real estate, patents, other intangible assets) OR if your company is going to have multiple owners that may come and go over the years, partnership tax law allows for this to happen on a tax free basis in some instances. In other words, an LLC can give you more flexibility. An S-Corporation at times will have more restricting provisions due to corporate tax law. This is why most real estate developers and multi-owner service companies utilize LLCs. If your company has only a few owners (even one) and you do not anticipate frequent ownership changes, the corporate law restrictions may not seem too restraining.
S-Corporation owners will be required to take a salary from their business. There is flexibility in the salary amount, but the IRS is strict on this issue as the pass-through of income to the owners is not subject to self-employment tax. On the contrary, the pass-through of income by an LLC to its owners IS subject to self-employment tax. There are some exceptions depending on the nature of the business and involvement of the owners.
One last point: both S-Corporations and LLCs pay a state fee (in California). S-Corporations pay a 1.5% tax on profits (with an $800 minimum tax) and LLCs pay an annual gross receipts fee that ranges from $900 on revenue of $250,000 to $11,790 on revenue of $5,000,000 or more. It may be necessary to look into the future and make some calculations to determine which entity type would result in more state tax.
Hopefully this information can help make the decision a little easier. However, the choice of entity is a serious consideration and getting help from competent professionals is highly recommended before signing the papers.
Russ Wertz – Founder and CEO of Wertz & Company, LLP, a Professional Services Firm located in Orange County, CA that specializes in working with entrepreneurs along their journey to success.