While many business owners get started without paying heed to corporate structuring, they will eventually get to a point where protecting their assets from tax authorities and litigators will become important.
Of all the ways to structure a company, the LLC and S-Corp are two methods that entrepreneurs have been using to organize their business assets.
Which of these corporate structures are right for owners? It depends on their priorities; below, we will break down scenarios in which either an LLC or an S-Corp makes sense.
1) Simplicity is a priority
Successful business owners are busy: they don’t have a lot of time to burn, so minimizing its usage on administrative tasks is a top priority.
The process by which an LLC is organized is simplistic, as its application form takes up a single page, guidelines are straightforward, and the owner doesn’t need to file a separate return for it, as they only need to report income on their personal income tax return.
2) Cash reserves are limited
Another distinct advantage of an LLC is that the application fee for setting one up is very inexpensive. In most jurisdictions, you will only need to part with a couple hundred dollars for the privilege of applying for this business structure.
In the early stages of a start up, every dollar counts, so minimizing the amount of capital allocated to unproductive but necessary expenses is vital.
3) Some shareholders are not American citizens
An inescapable fact of business in the 21st century is that more companies have not just employees, but stakeholders that reside outside of the United States of America.
While other corporate structures place restrictions on ownership on non-American citizens, an LLC allows those without US citizenship to own a stake in a company which it is organized around.
An S-Corp is the best structure for a business if…
1) Shareholders wish to receive dividends from excess profits
A key benefit of an S-Corp is that it allows the business owner to pay out dividends from profits after necessary expenses have been addressed.
By paying stakeholders a “reasonable” salary (as defined by the regulation of an S-Corp), any profits that are left over can be distributed in the form of dividends, which offer a lower overall tax burden than what is assessed on straight salary.
If there is a reasonable expectation of a consistent annual profit, this can be a great way to minimize the tax bill of an owner and their partners.
2) Cultivating an image of integrity is paramount
As advantageous as organizing a company under an LLC can be, its reputation often suffers due to bad actors in the business community.
If a business owner operates in an industry where reputation is a very important quality to maintain, an S-Corp can be a better organizing structure, as it has many rules and regulations to follow, and requires its owners to adopt official titles and responsibilities.
Directors need to be appointed to attach accountability for major decisions that are made with regards to company business, while officers are similarly appointed to handle day-to-day business operations.
3) The owner wants to pay less in self-employment tax
While LLC’s are simple and inexpensive to set up, they are subject to the quarterly self-employment tax that the IRS charges them, which can equate to a heftier tax bill for some companies.
Because an S-Corp structure allows owners to treat themselves as employees, the overall tax burden at the end of the day can be less due to the ability of S-Corp stakeholders be privy to unearned income (dividends).
Disclaimer – This post was not prepared by a certified accountant and just serves to present basic, publicly available information. Consult your tax professional before making any decisions.