LLC vs. S-Corp (hint: you may want both)
Which is right for you? An LLC or an S-Corp, or maybe neither? (Hint: the answer could be both) This article covers the benefits and drawbacks of each entity, as well as the benefits and drawbacks of doing business as a sole proprietor or regular corporation, also called a “C-Corp.”
Do I have to incorporate a business at all?
In some cases, your local, state, and federal government doesn’t care if you incorporate your business or not so long as you are operating under your own name and reporting any business income and paying taxes on that income. There are a lot of people that do this—local handymen, t-shirt printers, artisans, and so on, although they’re not always operating legally.
Some jurisdictions will require you to obtain a business license even if you’re doing business under your own name. You can usually just go to your city hall and fill out some forms, or you can take care of everything online here.
If you’re just doing business using your own name or you simply have a business license, your business entity is called a “sole proprietorship” or a “DBA” which stands for doing business as. Some jurisdictions also call this an FBN or fictitious business name if you’re using a name that is not your own but have not filed a formal business entity.
This is obviously a fast, cheap, and easy way to get started with your business, but it could cost you everything. You could be personally sued and lose your personal assets in the course of doing business. If you’re doing something relatively simple and safe, like designing t-shirts or selling cups online, your likelihood of being sued is probably low. However, if you are sued you could lose everything.
Why to incorporate
If you incorporate a business, that business becomes a separate entity that protects you from personal liability.
Let’s say you have a business mowing lawns, and during the course of a day you accidentally injure someone or damage their property. If you have a separate business entity, like an LLC or S-Corp, then the plaintiff will have to sue that business and only business assets can be affected, which are often minimal for small businesses.
If you don’t have a legal business entity, then you could have to sacrifice your house, your car, and anything that you own to cover the damages.
When you incorporate a business, you also own that business name and show that you’ve taken steps to become a legitimate legal entity.
This is why most people today choose to incorporate as either and LLC, S-Corp, or combination of the two. Since business filing starts at $79 and can protect you from losing everything you own, it’s kind of a no-brainer.
Let’s look into the two most common types of small business entity.
What are the benefits and drawbacks of an LLC?
LLC stands for Limited Liability Company because it limits your personal liability without all the complications of setting up a corporation. The LLC was invented over 40 years ago in Wyoming, based on a European business entity, and today LLCs make up over two-thirds of all new companies formed.
LLCs are much simpler than corporations. If you form a corporation, you have to have shareholders that elect directors—so now you have a board of directors. Those directors appoint officers—so now you have a president, vice president, etc. who then run the company. It’s a complicated three-level structure, and for most small corporations, you are all three of those—the shareholder, director, and officer. But in that set up you have to wear multiple hats, so nobody really wants to do all that unless you need to start a big company right away.
That’s why so many people choose the LLC—fully 70% of businesses formed on MyCompanyWorks.com are LLCs. They allow you to set up an official business entity that protects your personal assets, while being nearly as easy and simple as a sole proprietorship. Instead of the directors, officers, and shareholders of a corporation, you only need one person called a member. Most LLCs are single-member LLCs, but you can have multiple member LLCs as well and share ownership.
There are no citizenship requirements for LLC owners and LLCs can own and be owned by other LLCs, which, as you’ll see in the next section, is an advantage they have over an S-Corporation. LLCs are very flexible and you can write operating agreements and rules that allow you to be incredibly detailed on how your business is run or make it very very simple. Many of our customers like to choose the most simple entity that protects their assets and is not hard to run, and the LLC is the best choice every single time.
Also, LLC tax filing is simpler than a corporation’s.
Drawbacks to LLCs are very minimal. The only downside is if you ever want to become a venture-capital-backed company, you will almost always have to file a C-Corporation. However, most states will now allow you to convert an LLC to a corporation, so there’s really nothing to worry about. If you want to start your business and protect yourself as simply as possible then get started with an LLC, and when you’re ready to grow, convert it to a corporation.
Most people don’t know that Facebook started as a Florida LLC, and converted to a corporation later when they needed to.
What are the benefits and drawbacks of an S-Corp?
As we already discussed, a huge benefit of having an official business entity like an S-Corp is that it protects your personal assets in case you get sued during the course of business. An S-Corp. provides that protection, plus some added tax benefits as a “pass-through” entity.
The S in S-Corp simply means small. An S-Corp is limited to 100 shareholders and is not taxed at the corporate level. Whereas a regular corporation’s income is taxed twice—once at the corporate level and again at the personal income level—an S-Corp is just a pass-through entity that lets you pass corporate earnings on to yourself and your other shareholders, if you have any.
The drawbacks to S-Corps are that they are limited in size, you have to be either a US citizen or green card holder, and you can’t own other businesses or be owned by another business as an S-Corp, whereas an LLC will allow you to own and be owned by other businesses. S-Corp taxes are also more complicated to file than an LLC, and you’ll need at least a bookkeeper and probably an accountant to help you at tax time. Also, S-Corporations cannot deduct certain items that regular “C-Corporations” can like healthcare and travel. Ask your tax advisor for specifics.
Should I get a C-Corp instead?
The only reason to file a corporation is if you want to have more than 100 shareholders or attract venture capital. Basically, if you want a huge company, then it will need to be a C-Corp. But, if you’re starting out, it might be considerably cheaper and easier to start as an LLC until the time that you know you can attract those shareholders and funding. C-Corp structures, taxes, and filings are the most complicated of all, plus you get double taxed. Current taxation for corporations is 21%, and that’s before anyone gets paid and pays personal income tax. So, if your company makes $100,000 in its first year, the most you can make is about $79,000 before your personal income tax and any state taxes and fees. If you had chosen an S-Corp, you could have been paid almost all of that before having to pay any tax on it.
LLC vs. S-Corp Summary
If you’re just getting started, an LLC is probably the route for you. The setup, management, and taxes are easy. If you’re looking to save some extra money on taxes, you can consider actually adding an S-Corp election to your LLC, which will let your LLC file taxes as an S-Corp. But remember that if you do this, you’ll have to deal with more complicated corporate tax filings, and probably have to hire some help.
Once you’ve decided on a business entity, you need to choose which state you want to file it in. 9 out of 10 times that will be your home state, but there are advantages to filing in other states, especially Delaware, Nevada, and Wyoming. Once you file, you’ll need to apply for your FEIN, which is basically your business’s social security number, and then open a business bank account. Check out our business startup checklist to see everything you need in one place.
Best of luck!
Did you know?
The corporate tax rate was just lowered to 21%.
A husband and wife can count as a single shareholder for an S-Corp.
If you go to get venture capital or funding, they’re almost certainly going to require you to get a Delaware C-Corporation. Delaware has very favorable laws for business.
Large corporations typically own and create other corporations to separate liability. For example, Amazon may file a separate corporation for a single distribution center and own that under another corporate entity.
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