Before the formation of LLCs came along, the only way for the owners of a business to have limited personal liability, was to form a corporation. The problem was that not many entrepreneurs wanted the hassle and expense of incorporating, not to mention the complexity of dealing with corporate taxation. An easier option was to form a special type of corporation known as an S Corp, which is mostly like any other corporation except for the fact that the business profits are passed through the owner, just like in a sole proprietorship or partnership, rather than being taxed to the corporation, at the corporate tax rates. In other words, S corporations offer the limited liability of a corporation, with the pass through taxation of a sole proprietorship or a partnership., For a long time, an S-Corp was a good compromise for a small to medium sized business, though they still had to deal with the requirements of running an S Corp, including having all the meetings, keeping the minutes from the meetings, and other legal obligations that a corporation requires.
However, when the LLCs were created, they offered and even better option. LLCs are similar to S corporations in that they combine limited personal liability with the pass-through tax status, however LLC’s are not subject to the many regulations that the government put on S corporations.
Here is a list of the major differences between S corporations and LLC’s.
- Ownership restrictions- an S Corp may not have more than 75 shareholders, all of whom must be U.S. citizens or US residents. When forming an S-Corporations, some of the C corporation benefits such as being able to set up stock options and bonus plans to bring in public capital, are pretty much out of the question. Even when an S corporation initially meets the US citizen or resident requirement, its shareholders can’t sell shares to another company, another corporation, an LLC or a foreign citizen, because it may lose its’ S Corp tax status. In the case of an LLC, any type of person or entity can become a member. When I say any type of person or entity I mean: a US citizen, a foreign country citizen, even another LLC, corporation or limited partnership can become a member.
- Allocation of profits and losses – shareholders of an S corporation must allocate profits according to the percentage of stock each owner has. For example; if you own 25% of the S Corp ABC stock, you will receive 25% of the profits or losses, even if you want more or less. On the other hand, owners of an LLC may distribute profits and the tax liabilities that goes with that, however they see fit, without regard to each member’s ownership shares in the company. For example; If you have 25% of the business, you can receive 775% of the profits if the other members of the LLC agree. – The IRS may have some rules for situations such as this, however, your CPA will guide you through that.
- The thirds big difference between S corps and LLCs has to do with the corporate meetings and record keeping rules. For S corporations, shareholders, in order for the company to keep its limited liability protections, must follow all the corporate rules: If the S Corp is publicly traded, they have to issue stock, elect officers, hold regular board meetings including a board of directors and shareholders, and follow all the other mandatory rules in their particular states corporate code. LLC owners don’t need to jump through most of these legal hoops, they only have to make sure that there is a management team its agreement for making major decisions and then may go about their business.
- The 4th difference is the treatment of losses for tax purposes. S corporation shareholders are at a disadvantage if their company goes into a heavy amount of debt. For examplee, if you borrodw money to open the business or want buy an office building. This is because an S corporations business debt cannot be passed along to the shareholders unless the shareholders have personally co- signed and guaranteed that debt. On the other hand, LLC owners can typically reap the tax benefit of any business debts, cosigned or not. This can translate into a nice tax break for owners of an LLC who carry some debt.
Do you find these differences interesting? Here we have compared the S corporations and LLC’s, because C corporations are much more complex and if you are looking into opening a C corporation, I definitely recommend you to talk to an accountant that specializes in corporations.
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Joeel & Nataile are co-founders of Transformation Academy®, where they train leading-edge entrepreneurs, leaders and life coaches how to master their mindset and create a purpose-driven business. They have started more than a dozen businesses, and trained over 500,000 coaches from 200_ countries and territories. Joeel is a former psychology professor with a Master’s Degree in Counseling and Education is currently completing his dissertation on eudaemonic happiness for a Ph.D. in Psychology.