Incorporate your business: LLC vs an S corp
When it comes to an LLC vs an S corp, an LLC provides the owners with a shield to protect them personally from any financial burden created by the business, if properly set up and maintained.
Before starting a small business, it’s important to understand the various types of corporate structures that are available and the benefits and disadvantages of each. This is especially true in the construction industry, where exposure to financial loss can be high. We have already talked about the advantages and disadvantages of a sole proprietorships vs a partnership. Now, read about the advantages and disadvantages of an LLC vs an S corp.
Limited liability company (LLC)
If properly set up and maintained, an LLC provides the owners with a shield to protect them personally from any financial burden created by the business. The main advantages are:
- The owners share limited liability for business debts, judgments or other liabilities, regardless of how much control they have over the business
- Business profits and losses can be allocated to the owners at different levels to the percentage of ownership. For example, a 10 percent owner can be allocated 25 percent of the business profits.
- Owners have options as to how an LLC will be taxed, either as a partnership or a corporation.
However, there are also disadvantages to an LLC vs an S corp. An LLC is the most expensive to set up. If you hire an attorney or an accountant to create your LLC, and then add the cost to file with the state, you could spend $1,000 to $2,000. While this cost is a “disadvantage,” the protection you will receive from personal financial loss makes this a smart expenditure.
In addition, one more disadvantage to an LLC vs an S corpwith is that with an LLC, business accounts must be used only for corporate expenditures to maintain the corporate “shield”. If owners do use business accounts for personal debts or vice versa, the personal protection against business losses can be lost.
Finally, with an LLC you must file an annual report with the state and will probably have to pay annual fees.
For a small, single owner, an LLC affords the most personal protection against business loss, with the least amount of paperwork and fewest tax complications; however, this is only true if all business and personal finances remain totally separate.
Subchapter S corporations are similar to LLC’s in most respects, but there are some potential tax advantages if they are properly set up and maintained. The main advantages of an S corporation to an LLC include:
- Owners enjoy limited liability for business debts, judgments or other liabilities
- Owners share the net profits of the business and report that share on personal income taxes
- Owners share the net business loss and may be able to offset other income by reporting this loss on personal income taxes
- If personal and business accounts are kept separate (as with an LLC), the S corporation allows more flexibility in applying the income tax code.
- Shareholders can allocate compensation between W-2 wages (subject to employment taxes) and distributions of corporate profits, which are not subject to employment taxes.
There are also disadvantages. With an S corporation, personal protection against business liability is proportionate to any personal guarantees made to lenders (if any) to establish lines of credit for the business to operate. This is not the case with an LLC. S corporations are more expensive to set-up than a sole proprietorship and there is more paperwork.
Articles of incorporation that define officers and shareholders must be filed with the state, and annual meeting “minutes” of a shareholders meeting must be prepared by an attorney and filed each year. But, while this process is indicated as a disadvantage, if properly maintained, an S corporation affords the most protection from personal loss.
While these are the basics, check your state’s requirements. The laws, tax issues, documentation and costs related to setting up a business vary from state to state.
—By Bruce Webb