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S Corp vs LLC for Small Business Owners

  Sanjiv Gupta CPA  Published 

Let's start by understanding S Corporation

S Corporation is a corporation that has made S election in their tax filing with the IRS. S corporations have at least one shareholder who owns more than 75% of S corporation stock and S corp uses flow through tax reporting, which means that S Corp doesn't pay corporate income tax, instead it "passes-through" income and losses to Shareholders for their personal taxes. 

S corp shareholders can deduct distributions from S Corp on their personal return. S corp profits flow through to the shareholder and is taxed at individual level S corp structure provides for double taxation protection S corporation stockholders generally have limited liability. 

S corporations cannot have more than 100 shareholders S corporations avoid double tax on dividends, which pass-through S corp owners pay very little self-employment tax S corporation can't have nonresident alien shareholders. S corp must have only one class of stock S corp has perpetual life.

What is LLC (Limited Liability Corporation)

Limited Liability Corporations is a legal entity that provides its members limited liability and can be treated as sole proprietorship, partnership or corporation if business structured as S Corp.  

An LLC (short for "Limited Liability Company") is a hybrid entity, with some of features that S corporations and C corporations possess. While S corporation shareholders have limited liability like S corp, they also get taxed  like a partnership.

- An S corp is more suitable for small business owners who want to be taxed like individual S shareholders but without the S Corp has. S corporation provides you limited liability, corporate tax breaks and annual filing requirements to mention some of its benefits over LLCs. S corporation should be considered if you are a small business owner and if you want to avoid the S S Corp has.

- LLC is more suitable for small business owners who try to have some of features that S corporation and C corporation possess. S corp has limited liability (no shareholder personally responsible for business liability). S corp provides flow-through taxation to owners aka partner like nature but member who can have 2 key negatives - double taxation and financial disclosure requirement. S corp is not suitable for personal service businesses. 

Where should you form your company?

A number of S Corp owners are taking advantage of the fact that there are many places in the U.S. where S Corps pay zero income tax. In some cases, this is because state corporate income taxes are 0%. And in other cases, this is because the federal government does not allow S Corps to pay tax, even though the S Corp has operations in a state with corporate income taxes.

- S Corp owners are taking advantage of this fact by choosing the S Corp jurisdiction with which they file their S Corps.

- S Corp owners are also taking advantage of this fact by choosing the S Corp jurisdiction with which they register their S Corps.

- S Corp owners are also taking advantage of this fact by choosing the S Corp jurisdiction with which they form their S Corps.

Many S Corp owners have chosen Delaware as an S Corp jurisdiction, even when other equally good S Corp jurisdictions exist where the S Corp does not pay income taxes.

- The reason for this choice is that a S Corp can easily be converted into a Delaware LLC and vice versa. This fact is behind S Corps being the most favored S Corps jurisdictions for S Corp owners who want to stay in an S Corp jurisdiction which does not have corporate income taxes.

- S Corps are popular because they allow single member LLCs, but S Corps also offer other advantages over LLCs. S Corps do not require the S Corp owner to get personally involved in S Corp liability filings or LLC liability registration.

- Sanjiv Gupta CPA recommends forming the company in the state where you do business/resides.  For example, you should form the Company in California if you are living and doing business in California.