Picking An Entity – Considerations for the Small Business Owner
We tend to form entities for small businesses, and as such, the choice generally boils down to whether to form an S Corp or an LLC. There are certainly other entities, but these are the two that usually meet the needs of the small business owner and will be our focus here today.
When you select your business type, you need to consider what it is you are trying to do. You are creating a legally distinct entity which is primarily designed to limit your liability. If you are doing business without one of these protective entities, you are exposing your personal assets. An LLC, S Corp, or other entity can be a shield against your personal assets being seized to satisfy the debts and obligations of the business. Piercing that corporate veil can only be done under specific circumstances – but that’s a post for another day.
Both entities have things in common, and there are some noteworthy distinctions. For instance, both allow for “pass through” taxation. Both limit your liability and help shield your personal assets. Both are legally distinct entities that are created by filing with the state, and have certain fees. And both are subject to ongoing state formalities.
Some Primary Differences
Of course, the best way to decide between the two would be to examine some of the key differences. The IRS restricts S Corp ownership, but does not restrict ownership of limited liability companies (LLCs). These IRS restrictions include the differences in the number of owners allowed – LLCs can have an unlimited number of members; S corps can have no more than 100 owners, called Shareholders; Restrictions on citizenship among owners – LLCs may have Non-U.S. citizens/residents as members while S Corps may not. An LLC can be owned by other entities such as C Corps, S Corps, other LLCs, partnerships, and trusts, while an S Corp cannot.
As mentioned above, S Corps have more internal formalities. While LLCs are recommended to follow some similar formalities, they are not required. Some of these formalities are adoption of bylaws, the issuance of stock, holding annual director and shareholder meetings, and keeping meeting minutes with corporate records.
There are also notable differences in the management and running of the business. Owners of an LLC can choose to have the owners (called members in an LLC) manage the LLC. Alternatively, they may elect to have managers manage the LLC. When members manage the LLC, it becomes very similar to a partnership. When the LLC is run by managers it more closely resembles a corporation, with members not necessarily involved in daily business decisions.
S Corps, on the other hand, have directors and officers. The board of directors handle major decisions but generally do not oversee daily operations. Instead, directors elect officers who manage the day-to-day.
There are also tax considerations, most notably the self-employment tax. We at LeFebvre Law, PLLC recommend that a qualified tax professional be consulted with regards to the pros and cons of the tax issues on either of these entities.
Tim LeFebvre, Esq.