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Read time:  3 to 5 mins.

Assuming you’ve read the previous post, you understand how annoying it is to incorporate a business and you’ve decided that it is still something that your business needs.

The next question is: Which legal entity should a small business consider?

After googling the topic, a small business owner will quickly come to realize that there are two clear choices – the S Corporation (“S Corp”) or the Limited Liability Company (“LLC”).

Inevitably, every successful small business owner must decide whether to become an S Corp or an LLC.  These two legal entities have a number of similarities such as limited liability protection (note: either entity has its shortcomings in asset protection) and avoidance of double taxation.  But, why has the LLC become so popular, while the S Corp has faded from the public’s eye?

10 second history:

The S Corporation has been around for 50 years compared to the LLC which has become prevalent in the last 20 to 30 years.  The S Corporation is the big brother because it was created first.  Times have changed and the LLC was created to fit the needs of an economy that is constantly evolving.

S Corp

To create an S Corp, you must either have a C corporation or you must create a new C Corporation.  Then, you must file Tax Form 2553 electing to be treated as an S Corp.  Thus, you are a corporation that gets special treatment.  This is an important fact to remember.  The owner of a corporation must maintain a board of directors, maintain minuets to record board meetings, and all the other formalities that come with corporations.  (This is why S Corps are annoying.)

But, the S Corp has an important benefit that keeps it relevant – today.

S Corps allow owners to plan around the Self-Employment Tax.  Self-employment tax is 15.3% of your net income.  Obviously, this quickly becomes a very significant amount on your bottom line.  Generally, this is the sole reason small business owners decide to incorporate as an S Corp.

LLC

Limited liability companies have become popular because they are easy to create, very flexible and require little to zero maintenance.  But, the LLC does not allow small business owners to plan around the Self-Employment Tax issue.

An easy way to understand the difference between the two legal entities is that you’re paying for the convenience of flexibility in an LLC.  (note:  the cost of maintaining your S Corp properly through your tax accountant or attorney and the amount of net income you earn consistently could make the S Corporation’s SE Tax issue irrelevant.)

Bottom-Line

Should you decide to be an S Corp or an LLC?  It depends.  If your company is constantly changing and needs to be flexible with your needs, then an LLC is the right choice.  If your company is stable and consistently earning steady amounts of income and expect little to no change, then you should incorporate as an S Corp.  This is a very difficult decision to make without understanding all of your unique facts.  I always suggest you consult an informed professional (non-idiot).

Lastly, please realize that a business is like a baby with baby clothes.  Companies can very easily outgrow their corporate shells as the business changes.  You should evaluate whether or not your current corporate structure is still the right fit.

Thanks for reading!