By Kelly Bagla, Esq.
As a business attorney, the number one question I am asked is: “Should I be an LLC or an S-Corporation?” The business structure, in terms of the legal entity you choose for your business, significantly impacts some important issues in your business life. These issues include the exposure of liability and at what rate and manner you and your business are taxed. Your choice of corporate structure can also substantially affect issues such as financing and growing the business, the number of shareholders the business has, and the general manner in which the business is operated. You should be aware of some of the differences in business formation, especially when choosing between an LLC and S Corporation for your business.
OWNERSHIP OF AN LLC
An LLC (Limited Liability Company) is allowed to have an unlimited number of owners, commonly referred to as “members.” These owners may be U.S. citizens, non-U.S. citizens, and non-U.S. residents. LLCs may be owned by any other type of corporate entity and they substantially face less regulation regarding the formation.
LLC business operations are much simpler and the requirements are minimal. While LLCs are urged to follow the same guidelines as the S Corporation, they are not legally required to do so, such as adopting bylaws and conducting annual meetings. LLCs are not required to keep and maintain records of company meetings and decisions in the way that S Corporations are required.
The owners of an LLC are free to choose whether owners or a designated manager will run the business. If the owners decide to run the business then the business operates more closely as a partnership, which can pierce the limited liability protection of the owners and hold the owners personally label to creditors. One area where LLCs typically face more stringent regulation than S Corporations is that of transfer of ownership. Transfer of LLC ownership interest is usually only allowed with the approval of the other owners. In contract, stock in S Corporations is freely transferable.
OWNERSHIP OF AN S CORPORATION
The IRS is more restrictive regarding ownership for S Corporations. These businesses are not allowed to have more than 100 shareholders. S Corporations cannot be owned by individuals who are not U.S. citizens or permanent residents. Further, the S Corporation cannot be owned by any other corporate entity. This limitation includes ownership by other S Corporations, C Corporations, LLCs, business partnerships or sole proprietorships.
There are significant legal differences in terms of formal operational requirements, with S Corporations being much more rigidly structured. The numerous internal formalities required for S Corporations include strict regulations on adopting corporate bylaws, conducting initial and annual shareholder meetings, keeping and retaining company meeting minutes, and following extensive regulations related to issuing stock.
Regarding management of the business, S Corporations are required to have a board of directors and corporate officers. The board of directors oversees management and is in charge of major corporate decisions, while the corporate officers mange the company’s business operations on a day to day basis. Unless, a director of an officer of the company violate their ethical rules, they are usually never held personally liable for the company debts.
A major difference between the LLC and the S Corporation is that an S Corporation’s existence, once established, is usually perpetual, while this is not typically the case with an LLC, where events such as the departure of a member may result in the dissolution of the LLC.
DECIDING ON A BUSINESS ENTITY
A business owner who wants to have the maximum amount of personal asset protection and plans on seeking substantial investment from outsiders, or envisions becoming a publicly traded company will likely be best served by forming an S Corporation. An LLC is more appropriate for business owners whose primary concern is business management flexibility. This owner wants to avoid all but a minimum of corporate paperwork, does not project a need for outside investment and does not plan on taking the business public. Further, this business owner’s business will usually end if the owner decides to retire, has an accident or becomes disabled.
LLCs are easier and less expensive to set up and simpler to maintain and remain compliant with the applicable business laws since there are less stringent operational regulations and reporting requirements. Nonetheless, the S Corporation format is preferable if the business is seeking substantial outside financing or if it will eventually issue stock. Further, if the business owner wants to leave a legacy behind or wants to expand nationwide or even internationally an S Corporate structure would allow for this growth.
When deciding which entity is right for you, a consultation with a business attorney is highly recommended as there are a lot more deciding factors that come into play. You have already put in the hard work to get your business up and running, don’t let a simple and most often costly legal mistake cause you to lose it all.
For more information on how to legally protect your business please pick up a copy of my bestselling book: ‘Go Legal Yourself’ on Amazon or visit my website at www.golegalyourself.com
Disclaimer: This information is made available by Bagla Law Firm, APC for educational purposes only as well as to give you general information and a general understanding of the law, and not to provide specific legal advice. This information should not be used as a substitute for competent legal advice from a licensed professional attorney in your state.