S Corporation or Limited Liability Corporation?

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One of the biggest and most challenging decisions facing those that want to start a small business is determining which type of business entity to form. With a variety of entity options available, most small business owners end up choosing between creating an "S" corporation or a limited liability corporation. Learning the attributes, advantages and disadvantages of these two entities will help determine which one is right for your business.

"S" Corporation Attributes:

  • Limited Liability
  • Allow business owner to avoid double taxation
  • Requires filing of a federal and state corporate income tax return
  • Provides customary benefits of operating as an incorporated entity, including: transferability of unites, centralized control - if desired, active roles for workers versus passive roles for investors.

Limited Liability Corporation Attributes:

  • Limited Liability
  • Allow business owner to avoid double taxation
  • LLCs with more than one owner must file a partnership return; single person LLCs only include their gains and losses on a "Schedule C"
  • Provides customary benefits of operating as an incorporated entity, including: transferability of unites, centralized control - if desired, active roles for workers versus passive roles for investors.

Advantages of an S Corporation:

  • Avoid Social Security Taxes - an owner can often elect to take some of the gains of the business as dividends as opposed to salary. True dividends on S Corporation stock paid from the earnings of the corporation are not subject to Social Security taxes.
  • Lower Costs and Fees - Generally costs less to form than an LLC and currently, in North Carolina, the Secretary of State charges $35/year in fees for the S Corporation versus $200/year for a limited liability corporation.

Advantages of a Limited Liability Corporation

  • Low Maintenance Single Person LLC - once a single person LLC has been created, the Articles of Organization filed and the Operating Agreement prepared the entity requires very little upkeep. The owner may never again need to deal with a board of directors, officers, bylaws, stocks or annual meetings. Furthermore, when tax time rolls around the owner is only required to file the same "Schedule C" as he or she normally would have.
  • Less Restrictive - LLCs have fewer restrictions placed on them than an "S Corporation". In particular LLCs do not face the requirement that no "owners" be a corporation. Therefore, while a corporation cannot own an "S Corporation", they can readily set up an LLC and limit liability when starting a new venture.
  • Additional Limited Liability - the limited liability corporation offers greater protection of assets than other business entities. Because an LLC is treated like a partnership, in North Carolina, a judgment-creditor of the owner cannot attach and sell the units of ownership.

Disadvantages of an S Corporation

  • Restricted Access: Not every business qualifies to be an S Corporation. The qualification requirements can be found in the governing section of the Internal Revenue Code.

Disadvantages of a Limited Liability Corporation

  • Higher Costs and Fees: an LLC generally costs more to set up and annual fees charged by the North Carolina Secretary of State are greater than those charged for an S Corporation.
  • Can't Avoid Social Security Taxes: There is no opportunity to avoid Social Security taxes.

Source: H. Gordon, "S Corp or LLC?" Harry Gordon, 2010.