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LLC vs. S-Corp: Find out Which Will Boost Your Bottom Line - YouTube
Channel: Fundera by NerdWallet
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LLC vs. S-corp Script
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Hi, everyone.
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I'm Priyanka Prakash, senior staff writer
here at Fundera, and today I'm going to be
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talking to you about LLCs vs S-corps, with
a particular focus on the tax differences
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since that is what is going to affect your
company's bottom line the most.
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Choosing a business structure is obviously
a very important decision, and it really depends
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on the specific circumstances of your company,
as well as your future goals.
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But I'm going to cover some general information
that you should keep in mind when you're trying
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to decide between an LLC or an S-corporation.
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Now before getting to taxes, which is the
big difference, there are a few other things
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you should know.
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First is formation.
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Both LLC and S-corps are separate legal entities,
which means you have to file documents with
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the state in order to form the business.
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With S-corporations, this document is called
the Articles of Incorporation.
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And with LLCs, this document is called the
Articles of Organization.
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Now even though they have slightly different
names, both documents contain similar information,
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such as your business's name, address, and
registered agent.
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You would go through your state’s Secretary
of State or business filing agency to file
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these documents.
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The second category is liability.
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Both S-corporations and LLCs offer limited
liability protection for owners, which means
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that the owner or owners aren't personally
liable for the business’s debts and obligations.
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Say, for example, you own a landscaping business
and you organize it as an LLC and accidentally
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injure a customer.
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If the customer sues your business, they can
only recover out of the business’s assets.
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Your personal assets like your home or your
car or your personal bank accounts are safe
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from legal claimants and creditors.
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That is a huge advantage over being organized
as a sole proprietorship or a partnership
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because your personal assets are safe.
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The third category is management structure,
and that's where LLC and S corp start to branch
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off a little bit.
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S-corps have a three-layer management structure.
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Shareholders collectively own the business.
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Shareholders elect the board of directors,
who decide high level strategic and policy
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matters.
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And the board elects officers, like the CEO
or the CTO or the CFO, who run the business
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on a day to day basis.
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Because S-corps can issue stock, they're actually
better suited than LLCs for raising investor
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money.
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However, and this is important, S-corps are
limited to 100 shares and a single class of
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stock, which is a limitation that does not
apply to traditional C-corps.
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So just keep that in mind if you're starting
a company and you're planning to raise funds
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from investors or venture capitalists.
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LLCs are owned by their members.
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The members might run the business on a daily
basis or they might elect one of the members
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to serve as a manager.
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They might also elect a professional manager
from outside the organization, LLC members
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own what is called as “membership units”
in the business rather than stock.
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Now we come to the biggest difference of all:
taxes.
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The nice thing about LLCs is that you can
actually choose how you want your LLC to be
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taxed.
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And that kind of flexibility is really not
available with other kinds of business structures.
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By default, LLCs are taxed as pass-through
entities.
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That means that the business income, losses,
credits, and deductions flows through to each
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owner’s personal income tax return and are
taxed at each owner's personal income tax
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rate.
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The LLC would file Form 1065 as an informational
tax return, and each owner would use a Schedule
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K-1 to actually fill out the information on
their personal tax return.
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Now, in addition to business income taxes,
members in an LLC must also pay self-employment
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taxes on all company profits.
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Self-employment taxes cover medicare and social
security taxes for business owners.
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S-corps are also pass-through entities because
business income and losses pass through to
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the owners’ personal tax returns.
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The S-corp files Form 1120S as an informational
return.
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Any shareholder also gets a Schedule K-1.
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However, where the biggest difference is is
in terms of self-employment taxes.
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A potential advantage to S-corp owners is
that you can pay yourself in two different
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ways, either as salary or as distributions.
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Only salary is subject to self-employment
taxes; distributions are not.
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So you could potentially save a significant
amount of money by paying yourself through
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distributions.
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However, just keep in mind that the IRS does
keep tabs on this.
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You have to pay yourself a reasonable salary
for your job title and industry, so you cannot
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exclusively pay yourself in distributions
and pay no self employment taxes.
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That would not work with the IRS.
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Where things get really interesting is, as
an LLC, you can actually choose to be taxed
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as an S-corp and get the tax advantages that
come along with being an S-corp.
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In other words, you're still considered an
LLC from a legal and structural standpoint,
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but you opt to file taxes as an S-corporation.
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To elect S-corp status, you have to file Form
2553 with the IRS two months and 15 days after
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the start of the tax year in which you want
the change to take effect.
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For most businesses that follow a calendar
tax year, that’s March 15.
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The last category we should discuss is compliance
requirements.
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Compliance is a little bit more difficult
with an S-corp than with an LLC.
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In most states, S-corps, like any kind of
corporation, have to establish bylaws, holds
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director and shareholder meetings, draft meeting
minutes, issue corporate resolutions to make
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important decisions, and issue stock certificates
to sell stock.
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In many states, there’s also an annual business
tax on S-corporations called the franchise
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tax.
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Not following your state’s requirements
could mean that you have to pay fines or back
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taxes, or in a worst case scenario, you could
even lose your corporation status, so it's
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important to know your state’s requirements.
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LLCs have it a little easier in terms of compliance.
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There's a small handful of states that require
LLCs to draft an operating agreement.
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This is similar to corporate bylaws and contains
the owner's rights and responsibilities and
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the governing structure of the business.
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And some states also have an annual franchise
tax on LLCs.
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But, that's really it in terms of compliance.
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You're not required to hold shareholder meetings
since there's no stock that you're issuing,
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or director meetings.
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You don't have to draft resolutions.
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Holding meetings and keeping formal meeting
minutes is recommended for any type of business,
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but it's not required.
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So, in terms of time and money, an LLC is
easier to maintain than an S-corp.
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So, it comes down to which should you choose—an
LLC or an S-corp.
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On the one hand, LLCs have more structural
flexibility, and they're easier to maintain
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than an S-corporation.
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But S-corporations can help you save on employment
taxes.
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One compromise solution that often works well
for small business owners is to elect S-corp
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tax status for your LLC.
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This essentially lets you remain an LLC from
a legal standpoint, so you don't have to issue
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stock or elect a board of directors or take
care of those other corporation compliance
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requirements.
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But from a tax perspective, you get the advantages
of being an S-corp.
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You can treat some of your earnings as salary
and some as distributions and potentially
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save on self-employment taxes.
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One case where an S-corp might be a better
fit is if you're planning to raise funds from
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an investor or a venture capitalist.
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Most investors simply expect stock in return
for contributing money to a business, so that's
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important to keep in mind when you're planning
financing for your business and if you plan
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to raise money from investors.
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Whether you choose to form your business as
an LLC, an S-corp, or a different type of
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business structure, we recommend IncFile for
business formation.
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You can simply go to their website Incfile.com.
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Choose your entity type, as well as your state
of formation, and click “Get Started.”
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You'll see three different pricing tiers come
up, as well as the fees for filing incorporation
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or registration documents in your state.
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Each pricing tier has a slightly different
bundle of services, but all come with one
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year of free registered agent service, which
is a great deal.
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Ultimately, it's important to look to your
business's current circumstances as well as
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your future goals in deciding whether to organize
as an LLC, an S-corp, or an entirely different
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business structure.
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We recommend that you consult with a business
lawyer if you have specific questions about
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how to structure your company.
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We hope this was helpful, and we wish you
the best of luck.
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Follow fundera.com/blog for more small business
information, and subscribe to our YouTube
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channel for more videos.
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Thanks for watching, everyone.
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