What is an LLC?
A Limited Liability Company (LLC) is a business entity in the US that may be classified for federal income tax purposes as a partnership, corporation, or an entity disregarded as separate from its owner. Starting an LLC is relatively easy and inexpensive, and the guidelines are less stringent than an S Corporation.
What is an S Corporation?
An S Corporation is a business entity that elects to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. The key advantages to starting an S Corporation is that it offers tax benefits when it comes to excess profits, known as distributions. The remaining profits after “reasonable” salaries and payroll taxes can be distributed as dividends, which are taxed at a lower rate than income.
S Corporations and LLCs have many similarities, including:
- Limited liability protection for owners. Owners and shareholders are not personally at risk for business debts and liabilities.
- Separate legal entities. Both are also separate legal entities created by a state filing, and are subject to ongoing state-mandated formalities such as paying necessary fees.
- Pass-Through Taxation. Both entities adhere to pass-through taxation where no income taxes are paid at the business level. Business profit or loss is “passed-through” to owners’ personal tax returns. Any necessary tax is reported and paid at the individual level, and both can deduct pre-tax expenses, such as travel, computers, phone bills, advertising, etc.
Key differentiators for S Corporations and LLCs are:
- Deductible losses. S Corporations cannot deduct any of the company debt from losses, while for LLCs, the owner’s basis can include their share of certain types of the company’s debt.
- Ownership restrictions. There are much tighter guidelines on ownership for an S Corporation, compared to an LLC.
- LLCs can have an unlimited number of members; S Corporations can have no more than 100 shareholders.
- Non-U.S. citizens/residents can be members of LLCs; S Corporations may not have non-U.S. citizens/residents as shareholders.
- S Corporations cannot be owned by C Corporation, other S Corporations, LLCs, partnerships or certain types of trusts. This is not the case for LLCs.
- LLCs are allowed to have subsidiaries without restriction.
- Membership in LLCs are not freely transferrable, while S Corp stock is if certain IRS ownership restrictions are met
- Social Security and Medicare Taxes. In an S Corporation, owners pay FICA taxes on “reasonable” salaries for all employees, including themselves. In an LLC, owners pay a self-employment tax that also applies to their share of the profits. They are essentially treated like general partners for tax purposes.
- State Taxes. Different states treat S Corporations differently for income tax purposes. For example, New Hampshire treats them as if they were C Corporations, while others treat them as S Corporations with tax profits up to a certain limit. S Corporations are subject to state unemployment taxes and any disability taxes. Conversely, because LLC owners don’t pay unemployment and disability taxes, they save the tax costs but don’t receive benefits.
- Raising capital. S corporations can raise capital by issuing stock to investors, although they are limited to 100 shareholders. For LLCs, attracting outside capital investment may be more challenging.
- Cost to maintain. S Corporations may be a little more expensive and burdensome to maintain because they require formalities like issuing stock, holding shareholder meetings, and adopting bylaws. They also must pay annual filing fees in some states. LLC requirements are dependent on operating agreements and not on state law.
Which is right for you?
In our experience, many staffing firms choose to go the LLC route unless they anticipate significant growth and need to bring in additional equity partners. In that way, LLCs are often more attractive to smaller firms and start-ups, but it really depends on your individual needs and growth goals. Visit the startup resources section of our site or talk to us today if you are starting a staffing firm and need working capital to grow.