Should I Form an LLC or an S-Corp?

Once you decide to start a business, one of the most nerve-wracking initial steps involves choosing the type of legal entity for your business to take. Forming a corporation or company takes time and money, and if you go a suboptimal route, you may find yourself paying unnecessary taxes, opening yourself up to unwanted liability, or limiting your flexibility for growth. Continue reading for a discussion of the pros and cons of two common types of entities for small businesses: LLCs and S-Corps. Call a savvy Pasadena business lawyer if you need help with a California business law matter.

What’s an LLC?

A limited liability company (LLC) is a relatively simple business entity designed to have the limited liability features of a corporation while maintaining the tax efficiencies and operational flexibility of a partnership. Like a partnership, profits and losses “pass through” to the owners of an LLC (and owners report them on their federal tax returns), but like a corporation, owners cannot be sued directly for company liabilities.

What’s an S-Corp?

A corporation is a legal entity, separate from the owners, with a variety of strict regulations concerning the company’s formation, corporate structure, management, and reporting requirements to the IRS and state agencies. Corporations are owned by shareholders and must have features like bylaws and a Board of Directors. Corporate shareholders are insulated from business liability.

Corporations that have fewer than 100 shareholders can choose to be taxed as either an “S Corporation” or a “C Corporation.” An S Corp pays no taxes at the corporate level. Instead, individual shareholders pay their own taxes on distributions they receive, although these distributions are taxed at a higher rate. An S Corp is thus “pass-through” much like an LLC, and unlike other types of corporations.

How Do I Choose?

There are a variety of factors to consider when deciding upon a legal entity, and each type of entity carries pros and cons. Some of the factors to consider include:

• Formalities. Corporations have a variety of required legal formalities, including bylaws, shareholder meetings, director responsibilities, corporate structure, and reporting requirements. S Corps are limited to 100 shareholders. LLCs, on the other hand, are relatively easy to create, with few forms to fill out, low start-up costs, and no restrictions on the number of owners.
• Taxation. LLCs are pass-through, meaning profits and losses go to the owners as does taxation. Business income is taxed as employment tax, and LLC owners are considered to be self-employed and must pay self-employment tax contributions toward social security and Medicare. Although S Corps are also pass-through, only the wages of the shareholders are subject to employment tax, offering significant savings. LLCs only have to file taxes once a year, while S Corps face more regular and strict reporting requirements.
• Longevity. If a shareholder dies, goes through bankruptcy, or sells their shares, the corporation lives on uninterrupted. If a member of an LLC dies or undergoes bankruptcy, the LLC will be dissolved. If your business eventually plans to go public, you will likely need to convert from an LLC to a corporation.
• Transfer of Ownership. Transferring ownership of a corporation is relatively simple: Just transfer the shares. There are rules about transferring a certain percentage of ownership without approval from other shareholders, but generally, it is much more simple. Transferring ownership interest in an LLC can be significantly more complicated.

These are just a few of the considerations to take into account when deciding between an S Corp and an LLC. Talk to a seasoned business lawyer about your budding business to explore all of your options and find the best fit.

Get Help from Pasadena Business Lawyer Andrew Ritholz

If you are starting a small business in California or are facing legal issues with your existing Los Angeles business, consult with an attorney who understands your rights and can protect your interests with dedication and consideration. Contact Pasadena business lawyer Andrew Ritholz at 626-844-7102.