IN THIS ISSUE
DID YOU KNOW?
- THE IMPORTANCE OF
- BUSINESS STRUCTURE
- CHOOSING THE RIGHT
- STRUCTURE FOR YOUR
- BUSINESS
- UNDERSTANDING S
- CORPORATIONS
- UNDERSTANDING LIMITED LIABILITY COMPANIES (LLCS) WHEN TO PIVOT FROM AN LLC TO A S CORPORATION?
S Corp vs LLC: When is it Time to Pivot
by Audrey Jackson
Did You Know?
Your business structure affects your taxes, liability, management, and regulatory compliance. Selecting the right one can save you money, protect your assets, and streamline your business operations.
Starting a business is an exciting endeavor, and one of the earliest decisions you’ll need to make is choosing the right legal structure for your company. Two popular options for small and medium-sized businesses in the United States are the S Corporation (S Corp) and the Limited Liability Company (LLC).
The Importance of Business Structure
Your business goals should define the type of entity that you create. There are certain factors that are important to consider, for instance, legal protection, operations and tax management. However, businesses evolve over time, and what worked for your startup may not be suitable as your company grows.
The formation of a business is a critical decision for any entrepreneur or business owner, as it has far-reaching implications on legal protection, taxation, operational flexibility, and overall business strategy. It’s important to carefully consider the advantages and disadvantages of each structure and seek legal and financial advice to select the most suitable option for your specific business needs and goals.
Choosing the Right Structure for Your Business
Selecting the right business structure is a complex decision that requires careful consideration of various factors. The choice you make will significantly impact your business’s legal standing, financial obligations, management structure, and growth potential. Make an informed decision that aligns with your specific needs and long-term goals.
Understanding S Corporations
An S Corporation, or S Corp, is a legal structure that combines the liability protection of a corporation with the pass-through taxation of a sole proprietorship or partnership. This means that the profits and losses of the company pass through to the individual shareholders, who report this income on their personal tax returns.
To qualify for S corporation status, a business has to meet certain IRS requirements. It has to be incorporated domestically (within the United States), have only one class of stock, and not have more than 100 shareholders.
One of the primary advantages of S Corps is that they avoid double taxation. S Corps are considered “pass-through entities” because they pay no corporate taxes. Instead, they pay their shareholders, who are responsible for the taxes due on their personal tax return.
Pros of S Corps
1. Pass-Through Taxation: One of the primary advantages of S Corps is that they avoid double taxation. S Corps are considered “pass-through entities” because they pay no corporate taxes. Instead, they pay their shareholders, who are responsible for the taxes due on their personal tax return.
2. Limited Liability: Shareholders are generally not personally liable for the company’s debts or legal liabilities, protecting their personal assets.
3. Credibility: Being an S Corp can lend credibility to your business and make it more appealing to potential investors.
Cons of S Corps
1. Requirements: S Corps have certain eligibility criteria, including a limit on the number of shareholders and restrictions on who can be a shareholder.
2. Complexity: The formalities and paperwork associated with maintaining an S Corp can be more extensive than other business structures.
3. Tax Implications: While pass-through taxation is an advantage, it can also mean that you are personally responsible for taxes on business profits, even if they are not distributed to you.
Understanding Limited Liability Companies (LLCs)
An LLC is a flexible legal structure that provides limited liability protection to its owners while allowing for more straightforward management and taxation. LLCs are well-suited for a wide range of businesses, from small startups to larger enterprises.
LLCs are a hybrid business structure that combines the limited liability protection of a corporation with the pass-through taxation and flexibility of a partnership. LLCs can have one or more owners, who are called members. Members are not personally liable for the debts and liabilities of the LLC, and their share of the LLC’s income and losses is passed through to their personal tax returns.
Pros of LLCs:
1. Limited Liability: Like S Corps, LLCs protect the personal assets of their owners from business debts and legal issues.
2. Flexibility: LLCs are known for their flexible management structures and fewer regulatory requirements compared to S Corps.
3. Pass-Through Taxation: Similar to S Corps, LLCs offer pass-through taxation, allowing profits and losses to flow through to individual members.
Cons of LLCs:
1. Self-Employment Tax: While LLC members can avoid corporate income tax, they are generally subject to self-employment tax on their share of the company’s profits.
2. Limited Life: In some states, an LLC’s existence is limited, making it less suitable for long term succession planning.
3. Investor Attraction: LLCs may be perceived as less formal than S Corps, which can affect their ability to attract investors.
When to Pivot from an LLC to a S Corporation
There are a few key factors to consider pivoting from an LLC to an S Corporation, one being you having the advantage of reducing self-employment tax. S Corporation shareholders can split their income into salary (subject to payroll taxes) and dividends (exempt from self employment tax), potentially leading to tax savings. Another advantage is the potential for easier access to external capital, as S Corporations can issue multiple classes of stock, making it more attractive to investors and facilitating business expansion.