Updated: Jun 19
Starting a new business can be an exciting venture, but it can also be a stressful one. One of the most important decisions you will make is choosing the right legal structure for your business. Two popular options are Limited Liability Companies (LLCs) and S Corporations (S Corps). In this article, we will dive into the pros and cons of each to help you make the best decision for your business.
What is an LLC and S Corp?
An LLC is a business structure that combines the liability protection of a corporation with the tax benefits of a partnership. LLCs are flexible and can be owned by one person or multiple people, known as members. LLCs are also considered pass-through entities, meaning that the profits and losses of the business are passed through to the members and reported on their personal tax returns. Read more about setting up an LLC here.
On the other hand, an S Corp is also a pass-through entity that is taxed similarly to a partnership. However, an S Corp has the added benefit of being able to elect to be taxed as a corporation, which can provide some tax advantages. S Corps have shareholders who own the business and elect a board of directors to oversee the company. Read more about setting up an S Corp here.
Pros and Cons of LLCs
Limited Liability Companies (LLCs) are a popular choice for business owners because of their flexibility and liability protection. But like all business structures, they come with their own set of pros and cons. Let's break them down:
Limited liability protection: This is the big one. If your business is sued or incurs debts, your personal assets are protected up to the amount of your investment in the company. So go ahead and buy that fancy car, your business won't be able to touch it as long as you are running your LLC properly.
Pass-through taxation: LLCs are considered pass-through entities, meaning that the profits and losses of the business are passed through to the members and reported on their personal tax returns. This can simplify tax filing and save you money on taxes.
Fewer formalities: LLCs have fewer formalities than corporations, making them easier to operate and maintain. No need to stress over annual meetings or minutes.
Self-employment Tax: This 15.3% tax applies to your total net earnings (after expenses) from the business and can add up quickly.
Annual fees: Some states may require annual fees to maintain your LLC, which can add up over time.
Harder to raise capital: LLCs cannot issue stock like corporations, which can make it harder to raise capital. If you're looking for investors, you may have a harder time convincing them to invest in your business.
Pros and Cons of S Corps
S Corporations (S Corps) are another popular business structure option. They offer many benefits, but also come with some drawbacks. Let's take a closer look:
Limited liability protection: Like LLCs, S Corps offer limited liability protection to its shareholders, protecting their personal assets from business debts and lawsuits.
Pass-through taxation: S Corps are also pass-through entities, which means that the profits and losses of the business are passed through to the shareholders and reported on their personal tax returns. This can provide tax advantages individuals with real estate and other businesses.
Self-employment tax savings: Unlike LLCs, S Corp owners are only required to pay 15.3% self-employment tax on their wages (“reasonable compensation”), rather than their whole profits. This can save you hundreds of thousands of dollars on that pesky self-employment tax.
Formalities: S Corps have more formalities than LLCs, including the need for annual meetings and minutes. So if you hate paperwork, S Corps may not be for you.
Restrictions on ownership: S Corps have limitations on the number of shareholders they can have and the types of shareholders they can have, which may restrict the ability to raise capital.
Costly setup: S Corps are more expensive to set up than LLCs, and may require more ongoing fees to maintain. You also need to pay yourself “reasonable compensation” which requires payroll setup which can cost up to and above $1,000/year.
Overall, S Corps are a great option for businesses looking for tax advantages and the ability to issue stock. Just be aware of the added formalities and restrictions on ownership that come with this business structure.
Which One is Right for Me?
Choosing the right legal structure for your business ultimately depends on your individual needs and goals. If you want flexibility and simplicity, an LLC may be the right choice for you. If you are looking for tax advantages and the ability to issue stock, an S Corp may be a better fit.
It's important to remember that the decision you make now can have long-term consequences for your business, so it's essential to consult with your CPA or schedule a free consultation with a CPA at Iota Finance to learn more about whether an S Corp is right for you.
Deciding between an LLC and S Corp can be a challenging task, but by weighing the pros and cons of each, you can make an informed decision for your business. Whether you choose an LLC or an S Corp, remember to do your research and consult with a professional to ensure your business's success. Best of luck on your entrepreneurial journey!