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If you are not sure whether you should use a Subchapter S corporation or an LLC, consider the differences between a subchapter S corporation and a limited liability company (LLC).
Limited liability companies are a relatively new type of business entity that combine the personal liability protection of a corporation with the tax benefits and simplicity of a partnership. The main advantages and disadvantages of a corporation versus an LLC follow.
What are the advantages of a corporation over a limited liability company (LLC)?
1) Corporation profits are not subject to Social Security and Medicare taxes, however, like a sole proprietorship or a partnership, the salaries and profits of an LLC are subject to self-employment taxes, currently equal to a combined 15.3%. With a corporation, only salaries (not profits) are subject to such taxes.
2) Corporations have greater acceptance. Corporations have been around for a long time while limited liability companies are still relatively new. Generally the rules concerning treatment of corporations have been settled while this is not always the case with LLCs. However, this has become less and less of a consideration in recent years. Some states restrict the type of business an LLC may conduct.
3) Corporations can offer a greater variety of fringe benefits with fewer taxes. Corporations offer a greater variety of fringe benefit plans than any other business entity. Various retirement, stock option and employee stock purchase plans are available only for corporations. Plus, sole proprietors, partners and employees owning more than 2% of an S corporation must pay taxes on fringe benefits (such as group-term life insurance, medical reimbursement plans, medical insurance premiums and parking). Stockholder-employees of a C corporation do not have to pay taxes on these benefits.
What are the advantages of a limited liability company (LLC) over a corporation?
1) LLCs have fewer corporate formalities. Corporations must hold regular meetings of the board of directors and shareholders and keep written corporate minutes. Members and managers of an LLC need not hold regular meetings, which reduces complications and paperwork.
2) LLCs have no ownership restrictions. S corporations cannot have more than 100 stockholders. Each stockholder must be an individual who is a U.S. resident or citizen. Also, it is difficult to place shares of an S corporation into a living trust. These restrictions do not apply to LLCs (or C corporations).
3) LLCs have tax flexibility. By default, LLCs are treated as a "pass-through" entity for tax purposes, much like a sole proprietorship or partnership. However, an LLC can also elect to be treated like a corporation for tax purposes.
As tax considerations are generally the most important in determining whether you use a subchapter S corporation or a limited liability company, we strongly suggest you consult your CPA or other tax advisor in helping you make this decision.