S corporation vs. LLC in Practical Terms

S Corporation vs. Limited Liability Corporation (LLC)

There are two (2) major entity structures that small businesses typically use. In this article, we will compare and contrast the differences between an S corporation and a LLC. There are three (3) factors to consider when determining whether an S corporation or an LLC is best for you.

COSTS TO SET-UP
The first and often times most important factor is the costs to set-up and maintain the corporate or LLC structure. Generally, a most business owners will elect to be considered as an S Corporation because it avoids double taxation of a Corporation. A regular corporation must pay taxation on employee wages and any distributions to shareholders resulting in “double taxation”. In contrasts, a business owner can elect to operate as an S corporation and eliminate “double taxation” and be taxed like they do not have an individual without a corporation. There are certain requirements to be treated like an S corporation, but that is beyond the scope of this article.

In Illinois, a Corporation costs $175 to incorporate and generally, this process takes two to three weeks. There is a way to speed up the incorporation process called “Expedite Service”. Expedite service means that the Secretary of State can expedite your incorporation and turn it around within 24 hours for an extra $100 filing fee. Thus, a Corporation costs $275 to incorporate within Illinois if you want to use their expedited service. In contrasts, an LLC is more expensive to create and an LLC costs $500 for the regular service and $600 for the expedited service. With a Corporation and LLC, there are annual report fees that the business owner(s) must consider. For a Corporation, the costs of an annual report are generally $100. Whereas, the costs for an LLC are generally is $250 for the filing of the annual report. In my experience, the costs to set-up and operate is an important factor and most business owners do not need the complexity of a Corporation.

FLEXIBILITY

Flexibility is an important factor in determining whether to pick an S corporation or an LLC. In terms of flexibility, an LLC is a much better business entity than the S corporation. An LLC is similar to a partnership or sole proprietorship structure because business owners can set up their LLC as though there are no formal requirements. On the contrary, an S corporation has certain requirements such as there can only be one form of stock. For the majority of business owners, the one form of stock limitation is not a big deal because they would not use the flexibility features of an LLC. Thus, an S corporation has a formal structure requirement that does not offer business owners the option of great flexibility. An S corporation is like a template website where you must insert the words and structure of your website in a restricted manner. An LLC is similar to a customized website because you can set-up the website in any manner that serves your business purpose. For a select group of entrepreneurs, this flexibility feature of an LLC is vital because it enables them to have a corporate structure that fosters growth. My general rule is if your desire is to be a business that has limited shareholders and growth desire than the S corporation is the best business entity for you. In contrasts, if your desire is to grow a business with several employees and have multiple business owners, the LLC is the best entity choice for you. When comparing an LLC to an S corporation, an LLC is like a smart phone because it offers a lot of great features for those that will use them. However, there are a group of people that will purchase a smart phone and will not use the features of the smart phone. For instance, an LLC offers the ability to have multiple classes of ownership unlike an S corporation. This is important if your business is considering angel investors or any type of investors. With an LLC, there is a class of non-voting membership interests where the investor can have priority in getting paid back their investment in case of dissolution or liquidation. An S corporation does not offer this feature. Non-voting membership interest is also important because most business entrepreneurs want a non-active investor that does not attempt to manage the day to day business affairs. Non-voting membership interest achieves this goal because a non-voting membership interests is prohibited from making important day to day decisions. A non-voting membership interest holder may have a vote in vital corporate decisions such as whether to merge, consolidate, or dissolve the corporate entity. Another use of the flexibility of an LLC is creating incentives for employees to make corporate decisions in the best interests of the business. For instance, non-voting membership interests can be given to a key employee where they get a percentage of the profits of the LLC without the liability risks.
In conclusion, flexibility is a major benefit of an LLC and those entrepreneurs that desire to achieve high growth enterprises should strongly consider the LLC. However, most entrepreneurs do not fall into this category and the S corporation is sufficient for your business purposes.

TAXATION

An S corporation and LLC are both disregarded entities, which mean that the corporation or LLC is ignored for tax purposes. Simply put, this means that the S corporation or LLC assumes that you are either a sole proprietor or partnership without the benefit of a corporation or LLC. The LLC does have advantages that the S corporation lacks such as the flexibility of taking profits and losses without regards to your pro rata share of ownership. This simply means that if you are a fifty (50) percent shareholder, you do not have to take fifty (50) percent of the profits and losses as long as it is for a legitimate business purpose. This gives start- up companies and entrepreneurial companies the ability to structure incentives for an angel investor the ability to invest in a business. For example, the angel investor may want to offset a short-term capital loss with a short-term capital gain or offset a long-term capital gain with a long-term capital loss. Generally, a new business will generate losses at least on paper for the first three to five years. In monetary terms, the capital gains is currently a twenty (20) percent tax, which means that a $100,000 investment in a start-up business may be more similar to a $80,000 investment when you consider tax savings. Another example is a business owner that has been in business for seven years and wants to add a business partner. For the first five (5) years, this business owner may want a higher percentage of profits to reward him or her for their hard-earned work without losing the value of the limited partner or business partner. Thus, the flexibility from a tax standpoint of the LLC is advantageous.
Generally, an S corporation is more favorable from a payroll tax standpoint than an LLC because one must pay payroll taxes on profits of an LLC. This is solved by the LLC be treated as an S corporation for tax purposes versus a partnership or the S corporation owning the LLC. Personally, I love the asset protection benefits of an S corporation owning a LLC. In a business lawsuit, the owner of the business and the corporate entity (LLC or S Corporation) will be sued. If the S corporation owns the LLC, there is a small likelihood of the owner of the S corporation being sued individually. In contrasts, if an individual owned the LLC, there is a strong likelihood that the individual member would be personally sued in his or her individual capacity. Going back to the payroll taxes, an S corporation allows you to pay payroll taxes on a reasonably salary. A reasonably salary is most likely less than your profitability in many cases because your revenue is often times re-invested in your business venture.

In conclusion, your corporate structures for asset protection and growth purposes are critical decisions. LLCs generally are the best corporate structure for high growth entrepreneurial companies. Whereas, small businesses that aim to have few shareholders often times are better served with an S corporation structure. You should consult with your accountant and legal advisor regarding your entity structure for growth and tax purposes.
Sean Robertson is a tax planning and asset protection attorney concentrating in corporate counseling, asset protection, and estate planning for closely-held businesses and individuals. Sean Robertson is Managing Partner of Robertson Law Group, LLC, which is based in downtown Chicago at 35 East Wacker Drive, Suite 935, Chicago, Illinois 60601. Robertson Law Group, LLC may be reached at (312)-854-7102. Our website is www.RobertsonLawGroup.com.


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