While LLC can be compared with other business structures but in the case of S Corporations, it can be compared based on its system, as an S Corp is not a business structure like a C Corp but it is actually a Tax classification where you can even turn your LLC into an S Corp.
However, this tax classification is like a business structure as it has its differences and similarities with LLC, PLLC, and C Corp. As we proceed, we will be going through the details to help you in keeping your LLC or to turn it into an S Corp.
LLC (Limited Liability Company):
For anyone looking to create a startup or has a small-time business between themselves or with a partner then it would be wise to turn that business into an LLC.
- Overview of LLC Formation
To turn your business into an LLC, the procedure is relatively simple compared to turning it into a corporation. The procedure and the fees might vary between states, but in general, there are core elements that you must follow.
- You are required to pay the state filing fees through the articles of organization. And the fees will vary depending on the state.
- You then need a registered agent who will take care of the legal proceedings of the business. Oftentimes, business owners nominate themselves as the registered agent.
- You are required to have an attorney or an accountant who’ll handle the overall legal framework of the company. You can ensure that through legal agencies as well.
- You ensure reservation of your company name as well as take a name which is only yours and not taken anywhere else. It is, of course, comes with a fee that varies among states.
- It is incredibly significant to form an Operating Agreement to have documentation of the business framework, its members, and partners. For many states, it may be optional, but it’s essential to create one to have some weight for your company.
- The IRS needs you to create an EIN (Employer Identification Number) to keep track of your business. For some states and businesses, forming an EIN may not be absolutely necessary.
- Liability Protection in an LLC
One of the core advantages of an LLC is that if the business faces any sort of lawsuit or faces a significant debt, the company assets are likely to get seized, or the debt is paid through the company fund. The assets of the owners and members have 0 involvement with the lawsuit.
Because an LLC itself is a separate legal entity, in a sense it has its own life to deal with situations. Only if specific laws are breached depending on state jurisdiction will the owners be more involved with their assets to save their company.
- Taxation Considerations for LLCs
You are required to pay minimal or quite a few tax fees depending on the state in which you reside. As per tax considerations, in an LLC, you won’t be facing double taxation in many forms, like Texas, Delaware, and Wyoming. It basically means that in your net profit, you won’t be taxed twice (On Personal Income and Business Profit).
Based on state laws, most states have pass-through taxation where the profit is taxed only once from the owner’s income.
And, as for self-employment tax, that depends on the type of LLC because if it’s a single-member LLC, then the IRS sees that business as a sole proprietorship, and then that business is only subjected to Self-employment from their income from the company.
However, for a multimember LLC, which is seen as a partnership or a corporation, then each member that is active is subjected to Self-employment tax.
S corporation:
S Corp is like a business status that will let your business be somewhat of a fusion of a C Corp and an LLC with its Liability protection and pass-through taxation, respectively.
- Formation Process for S corporations
Let us go through the steps on how you can turn Business into an S Corp.
- First, ensure that you meet the requirements to form an S Corp as there are various laws given by the State and IRS. Things like, S Corp is limited to only 100 shareholders, take consent from all the shareholders in the formation are some of the eligibility requirements that you are required to follow.
- Just like any other Business Entity, make sure that you get a Unique business that has not been used anywhere, at least in the state.
- Apply with all the necessary documents by filling in the requirements to the articles of incorporation. Initially, your business will be formed as a C Corp, but after completing all the eligibility, it’ll be turned into an S Corp.
- After eligibility, you are now allowed to issue stocks for the designated shareholders. You need to make sure that the Shareholders are at least residents of the US.
- Similar to Corporations, you are required to elect board members and executives who will run the business.
- Similar to C Corps and LLCs, you are required to have an EIN number. To get an EIN for S Corp, you need to apply SS-4 form.
- After you fill in all the requirements for an S Corp, you are now required to submit Form 2553 to the IRS.
- Lastly, like other business structures, you now need to get the right permits and licenses to run your business.
- Liability Protection in a S corp
Similar to LLCs, S Copr, regardless of its tax policies and legal proceedings, makes sure that during any sort of lawsuits or debts, the personal assets and income of the shareholders are not used up in any way. S Corp being its own business entity is liable for everything except for a few exceptions in which there’s direct involvement or harm done by the Shareholders/Owners.
- Taxation Aspects for S Corp
One of the core advantages of an S Corp is that its taxation policy isn’t like a C Corp, where you are required to double taxation. S Corp is a fusion with LLC because it has pass-through taxation.
Which means that means that your dividend will only be taxed at your personal income level but not at your corporate income tax level.
Choosing the Right Structure: Factors to Consider
Let us now go through some of the key factors to consider in what you should be choosing to incorporate into your business or startup.
- Nature of Your Business
If you seek to create a business catering to a small customer base with not many intentions to expand and seek more accessible policies, then you should form an LLC, but if you seek to form a Corporation with hopes to expand in other states catering to various customers with regularities at your range, then you should form an S Corp.
For professional services, it is more suitable to create an LLC as professional services will let you create a PLLC which has suitable laws and policies that will assist your small business, whereas S Corp is more vast in terms of product and service generation as a corporation caters to a larger mass, not to one single customer.
Licensing is also easier in LLCs based on services and products but for S Corp, you need to meet up with the industry standards.
- Liability Concerns
As I have spoken before, both S Corps and LLCs have similar structures in terms of asset protection as the owner or the shareholders are not affected by their personal assets and money anyhow with company-oriented lawsuits or debts.
- Tax Implications
The process for tax considerations are also similar as well as both the business structure have passed through taxation, which means that there is no double taxation.
Legal and Regulatory Requirements
Let us now go through the limited details between legal and regulatory requirements for an LLC and PLLC.
- State-Specific Regulations
In terms of the primary procedure, the formation of an S Corp is the same in most states. It’s just that the bigger hassle comes through meeting the requirements and consistently maintaining them to keep the status.
However, state laws indeed differ when it comes to LLCs, as some states even change some core traits of an LLC along with fees and legal proceedings.
- Importance of Operating Agreement
For many states, it is optional to create an operating agreement, but here at RocketWave, we genuinely recommend you to create an Operating Agreement, and that is important for a number of reasons.
To understand the business ownership, business structure, members and their roles, transition in governance, regulations with state jurisdiction, professional licenses of the members, and Evidence of intent, all of these things are meticulously mentioned in an Operating Agreement. It may not be a requirement for various states, but an LLC doesn’t really have an identity without an Operating Agreement. But, for S Corp you may open an Operating Agreement but the business infrastructure will be governed by the articles of incorporation.
Advantages of LLCs:
Let us now go through the advantages of LLCs.
| Advantages | Reason |
| Simplicity and Versatility | The formation of an LLC is significantly streamlined, requiring only the formation process. Unlike other businesses, there is no requirement for specialized professional qualifications while putting together your team, making the process more accessible. Furthermore, LLCs provide stronger liability protection, giving its owners piece of mind. This corporate form provides greater flexibility, allowing for customization to individual tastes while also simplifying tax duties. Furthermore, the requirement for licenses and permissions generally applies to specialized services, allowing for greater access to various industries depending on the nature of the business. |
| Tax Benefits | For an LLC, there will be Pass-through taxation, which simply means you will be taxed only once on your personal income level. And as for self-employment tax that needs to be maintained if you opt for a partnership or a Corporation business. The self-employment tax rate is 12.4% for Social Security and 2.9% for Medicare. |
Advantages of S corp:
Let us now go through some of the core advantages of S Corp.
| Advantages | Reason |
| Pass through Taxation | The most significant difference between a C Corp and an S Corp is also the most considerable advantage of S Corp. There is not any double taxation in S Corp, which is similar to LLCs. You are only required to pay your taxes on your personal income level through the shareholder dividends, that is all. |
| Liability Protection | Just like we have discussed before, in case of lawsuits or any debts, since C Corp is a separate entity itself so naturally the shareholders or the owners will not be liable for those expenses through their personal assets. |
| Flexibility in Ownership | In S Corps, not only a variety of people, corporations, and entities can be the owners of the business, but the transfer of ownership is quite feasible as well. As a significant shareholder, you have a lenient procedure to transfer your ownership without causing any sort of chaos in the business, and also, upon the limitations of the Corporations, any individual, corporation, or trust company will be able to own stocks. |
Apart from these core advantages, there are other advantages like Self-Employment Tax Savings, a credible image, simplified reporting, employee benefits, and many more that will assist you in your decision.
Drawbacks of LLCs:
Let us go through some of the disadvantages of LLCs.
| Drawbacks | Reason |
| Limited Liability Boundaries | In contrast to PLLC, an LLC is only limited to industries that do not require professionals or licenses. The business may be necessary to hire professional employees as owners or may be required to turn it into a PLLC based on the services and state regulations. Also, the business may be exposed to Malpractice claims that will lead to several lawsuits and breaches of state laws, which will lead to the confiscation of company assets. |
| Licensing Challenges | Even if you may not be required to create a PLLC, there may be specific permits and licenses that you will need to pay because of the services you’ll be covering. But, if you had turned your business into a PLLC, then maybe those expenses could be levied depending on state protocols. |
Drawbacks of S corp:
Let us now go through some of the key disadvantages of an S Corp.
| Drawbacks | Reason |
| Only one class of stock | Even though the fundamentals of stocks are through raising investment but, it can often be a disadvantage for S Corp as it provides only one class of stock regarding dividends and distribution of assets. This is a significant drawback as investors often look to buy stocks based on convenience, which C Corporations provide. |
| Excess reporting and compliance costs | Unlike the other business structures, including LLCs, the process of maintenance and compliance of an S Corp is quite long and expensive. As the legal proceedings during formation are lengthy, along with the annual obligations to maintain things like Tax returns and Schedule K-1s to shareholders. Also, in many instances, if you don’t maintain all the obligations firmly, it may result in the termination of your S Corp status. |
Expert Insights: Legal and Financial Advisors Speak
In terms of Business Goals and Structure, you should know where your business will be in the long run and how you want to keep it,. That should give you the initial clarity if you’re going to keep your business as an LLC or turn it into an S Corp. Also, the type of products and services you seek to sell and the customer base along with it should clarify your decision as well.
Like, if you want to sell FMCG products to local customers where you need https://rocketwave.cofull autonomy of your business, then you need to make an LLC. Similarly, if your goal is to have investors on board and create a B2B along with a B2C business, then you could form an S Corp.
There are various legal hurdles that come along with both of them. I’m sure your registered agent and your attorney will guide you through, but initially, if you seek your business to be hassle-free in terms of paperwork, then you will be advised to create an LLC.
As your Financial input, based on your products and services, your accountant will assist you through the profit and loss metric along with the tax implications to guide you in your decision.
Conclusion
Hence, I hope you have now understood the basics of both LLCs and S Corp. We at RocketWave can assuredly assist you in your startup journey by creating your LLC that you can turn into an S Corp. Apart from all the key activities, advantages and disadvantages I’ve mentioned, things may differ based on state laws for both of these business structures.
For that, you need to research all by yourself as you may see that you have an LLC in a state, but it would be appropriate for you to turn it into an S Corp. While learning about the formation, you then see that the state laws are not that convenient for S Corps.
