What’s the difference between an S Corporation and LLC?
When setting up a business structure with partners, which business entity should I form and what are the pros and cons of each?
In this article we will discuss the typical business formations you see in the United States. We will discuss which business entity is best for you and the pros and cons of each.
These business structures can provide you, your family, and your business both tax benefits and protection from legal issues.
To set one up, contact John here at WP Blog Host, we can do this for you inexpensively and our work is superb.
Note: Choose your entity carefully. Setting up the wrong business structure for your business can cost you in many ways: taxes, regulatory restrictions, legal, and finance (stock) considerations are among a few. Give the design and structure of your business as much thought and consideration as you did your initial preparations.
The Different Business Structures
- Sole Proprietor
- Partnerships
- Corporations
- Limited Liability Companies (LLC)
- The New Series LLC
- Living Trusts
Sole Proprietor
This is the most basic business structure form as is not considered a business entity. It basically entails you getting a business license in your state, getting a bank account, and setting up shop. One person described it to me as you against the world. I highly DO NOT recommend this business structure for you. It provides you with no legal protection from others, limited financial options, and the least tax savings strategies.
So why do people not incorporate? Usually two reasons:
- They have no money and this is a cheap method to start a business
- They don’t know anything about business structures
Pros and Cons – Sole Proprietor
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Partnerships
People look to form partnerships when there are two or more individuals looking to start a for-profit, unincorporated business and are all part owners of it.
There are two basic types of partners – general and limited.
General partners assume all responsibilities as owners and managers whereas the limited partners are limited in their liability to the amount he or she invested in the business. Like sole proprietor, a partnership structured business is viewed as being one and the same as its owners.
General Partnership
This is probably the most used partnership form and is the easiest to set up. All partners manage the business equally and are all personally liable for its debts. There is very little
liability protection.
Limited Partnership – (LP)
This form of partnership consists of a general partner(s) and a limited partner(s). The general partner operates much the same as in general partnerships and basically “runs” the business. The limited partner is limited only to what they invested in the business and typically do not “run” the business. In other words, they are only responsible for those debts they contributed to the business.
Limited Liability Partnership – (LLP)
Much the same as a LP but is organized so that all partners have some degree of liability in the company.
Family Limited Partnership – (FLP)
A FLP is a partnership composing of both general and limited partners and is a great business structure for protecting family assets (especially when used in conjunction with other business structures and set up properly) and transfer of property.
As the name suggests, it works well when dealing with family, however, in reality it’s just a simple LP. The name really is only given to it to refer that the partnership deals with family assets. When we file FLPs, we are really filing a LP.
Typically the general partners would be parents or grandparents who want to pass down assets to their heirs when they pass away. The children would be the limited partners.
Pros and Cons – Partnerships
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Corporations
First let’s start with what a corporation is and where the best place to incorporate in will be (and why). Then we’ll move on to the different types of corporations.
Corporations are considered legal entities all on their own, separate from the business owner,
and are formed and licensed in the state they operate in.
You can think of a corporation kind of like a person all on their own. They have to file taxes, can own property and assets, buy and sell assets, raise money, buy a benefits package for its family (the employees), etc.
Because of this separation of owner and business, a corporation provides what is called a corporate veil. This means you and your personal assets, money, etc. are all protected from law suits and are separate from your business.
You may hear the term “Pierce the corporate veil.” This refers to the scenario when someone may want to sue you, for example, and not just your company. But since you’re incorporated and were acting as an employee of your business, however, you have that layer of protection since this person technically can only sue your business and whatever assets it holds.
State laws vary as to how well the corporate veil is protected. This is one big reason why the two most popular states to incorporate in are Delaware and Nevada. Of the two, Nevada is the best. Nevada provides the best layer of protection for business. Basically, the only way for someone to pierce your company’s corporate veil is if you commit fraud.
Nevada Corporations are Attractive Because
- Nevada has no franchise tax
- no corporate income tax
- no personal income tax
- does not have information sharing agreements with the Internal Revenue Service
- Nevada strongly protects the business owner
If you are starting or have started a business that doesn’t deal much in other states, make a lot of money, and your liability is relatively low, then you may simply just want to incorporate in your own state. If, however, you plan to do business country-wide or world-wide and protecting your assets is essential, consider incorporating in the State of Nevada.
How incorporating in Nevada but doing business elsewhere works
First you would incorporate your business in the State of Nevada. Nevada now becomes your domicile (your business’ residence). Then register your new corporation in your state of business (called foreign filling).
Types of Corporations
- C Corporations
- S Corporations
- Professional Corporations
- Non-Profit Corporations
C Corporations
The basics of what corporations are is described just above this subheading.
A C Corp is completely separate from the business owner. It pays its own taxes, pays you your salary, and then you pay your taxes. In other words, the business’ income does not pass through to your personal income tax reporting’s.
This can lead to what is referred to as double taxation (your company pays taxes and so do you on some or all of your company’s taxable income). While this may seem unfavorable, C Corps provide the widest range of tools to expand your business.
For example, you can have unlimited shareholders so you can raise as much money as you want. Also, C Corps are taxed differently: for the first $50,000 of taxable income, your business would only pay a tax rate of 15% (when a S-Corp pays at the standard rate).
C corps are a good design for companies that make and deal with a lot of money, have many employees and/or shareholders, have little or no chance of making a loss, and if expansion is likely.
Pros and Cons – C Corporations
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S Corporations
S Corporations are basically corporations that have elected to be taxed under Subchapter S of Chapter 1 of the Internal Revenue Code.
The two main points you should know about when it comes to the difference between a C Corp and S Corp is how they are taxed and how many shareholders you can have. There are, of course, other differences; but this article is about giving you the condensed necessary information needed to approach and speak with a professional.
As far as taxes go, S Corps don’t pay their own taxes like C Corps do (thus eliminating the double taxation problem). Instead, the taxable income is passed through to the shareholders (the owners).
In other words, if your company made $100,000 taxable income, you would show that income on your personal tax return (whereas a C Corp would first pay taxes on that $100,000 and then pay you your income and you would pay taxes on that income as well).
This form of pass-through taxation is especially favorable if you expect your company to make a loss for the taxable year. In this way, if your company paid more money out than what it made, those losses would pass through to your personal income taxes and can be written off as deductions (whereas if a C Corp had a loss, those losses would not pass through to your personal income tax).
There is one really nice feature of corporations I’d like to mention (both C and S).
As a corporation, you must conduct an annual board of director’s meeting to discuss your business. They can even be done more often than once per year. The best part is, this meeting and all expenses incurred because of it is tax deductible (and it can be held anywhere in the world).
Therefore, many small business owners schedule this meeting around family vacations. By doing this, their plane ticket, gas, food, etc. can all be written off on their taxes. If by chance you decide to go to Disneyland or some other from of entertainment, you can only write a portion of that off . . . but hey, that’s better than nothing.
Pros and Cons – S Corporations
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Professional Corporations
Businesses that require a license to practice must be formed as a professional corporation.
For example, the following professionals would have to form a professional corporation: dentists, veterinarians, CPAs, lawyers, doctors, chiropractors, etc. By forming a professional corporation, professionals can limit their personal liability for the malpractice of their associates. One downside to a professional corporation is that they are taxed a little differently than regular corporations . . . and not necessarily in a good way.
Non-Profit Corporations
Non-profit corporations are exempt from income tax. Such businesses may include: charitable, educational, religious, scientific, or literary organizations. If you wish to form a non-profit corporation, you may want to briefly review
Section 501(c) (3) of the Internal Revenue Service Code. These kind of corporations also need to be owned by more than one person and any excess funds (funds remaining after donations have paid for all expenses) must go toward the growth and expansion of business and services.
Limited Liability Company – LLC
The LLC business structure has become one of the most favorable business structures around, especially in real estate.
It combines most of the advantages of other business structures while limiting their disadvantages. They work much like S Corps; pass-through taxation, provide liability protection and asset protection for owners, require board meetings, business debts do not show up on personal credit, etc.
There is one big difference between the S Corporation and a LLC which makes the LLC structure
advantageous.
The following is probably the BEST example of why you need to take some time and think about what business structure is for you and your business.
In an S Corp, if there are 2 owners then income must be allocated to owners according to their ownership interests. In other words, if John and Bob formed an S Corp, they could structure it so John owns 50% of the business and Bob owns 50% of the business.
If, however, John performed 90% of the work over the year and Bob sat at home and did nothing, Bob would still earn the same amount of money as John (or is suppose to by law).
If instead they formed a LLC instead of an S Corp, then profit and losses can be allocated differently than ownership interests. Therefore, John could earn 90% of the income and leave Bob with the remaining 10% even though Bob owns 50% of the business.
You should consider this business structure using the same reasons to consider an S Corp except you should take into account whether or not you want to have control over who earns what profit regardless of ownership in the business.
Also, if you own real estate you may want to become familiar with LLCs.
For example, if you owned 5 rental properties and you had no liability protection and one of your tenants hurts themselves on your property, they could sue you. Everything you own could be attached to the judgment. If, however, you placed each of your 5 rental properties in its own LLC then that person could only sue the LLC that owned the property they got hurt on; all your other assets and rentals are insulated from this lawsuit.
Pros and Cons – Limited Liability Company (LLC)
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The New Series LLC
This is a new business structure which has yet to be fully tested in the courts and may not be recognized by all 50 states. It was designed primarily for real estate investments.
Normally, a real estate investor would set up a separate LLC for each house / rental property they own so that they are protected liability and asset-wise. This can be a huge headache, become expensive, involve lots of paperwork, and create a tax nightmare.
Using the new Series LLC structure, a real estate investor could place all their investment properties under one LLC which stipulates each property is sheltered from the other. Therefore, if someone hurt themselves on property A, they could not attach a judgment to property B (or anything else).
Also, the real estate investor could save a lot of time and money by only filing one tax return.
Living Trusts
A living trust is a legal entity but not quite the same as corporations. You can think of a living trust much like a will. It is a document you place instructions in to pass along your assets after you die. You can also mention certain instructions you wish to happen if you were to become comatose or living solely on life support.
A trust can own things just as a corporation can. It can own real estate, cars, jewelry, clothing, etc. Individuals with a lot of assets and/or equity typically look to form living trusts as an added layer of asset protection. Unlike a corporation though, trusts do not pay taxes (in your lifetime). Any profits or losses are passed through to the individual’s personal income tax.
Living Trusts have one huge advantage over a will. Because a living trust is privatized, it remains out of the courts and thus avoids the possibility of going to probate court if there are any issues that arise when the owner of the trust passes on.
What A Trust Consists Of
A trust consists of the following:
- Grantor – owner of the trust
- Trustee – the person who executes the instructions in the trust after the Grantor dies
- Beneficiaries – the one(s) who receive items/equity from the trust
Theresa Hoff (director of our incorporation services) wrote an excellent guest blog article entitled:
How A Revocable Living Trust Can Save Family Heartache if you would like to read more on this subject.
If you own a business or want to set up a business structure for asset protection, WP Blog Host can do this for you. We provide incorporation services and state trademarks. Simply use the contact form to get in touch with us or visit our incorporation home page and we’ll be happy to help. Our rates are low and our work is second to none.
Related posts:
- General Partnerships: A Not-So-Great Business Structure
- How To Split Business Income Between Partners
- How To Protect Your Assets Using Business Structures
- Welcoming Theresa Hoff – Director of Incorporation and Living Trust Services by WP Blog Host
- How A Revocable Living Trust Can Save Family Heartache
April 23rd, 2008 at 10:39 pm
i start a nevada llc to protect my privacy. The llc buys a piece of real estate owned by me appraised for $200,000 ( i sell it to myself) with a agreement of sale. The agreement of sale is for payments of $10.00 month for 30 years, with balloon payment after 40 years. I later get sued and all I have to my name is this $10/month agreement of sale. The creditor gets the junk note and $10/month….not my land. Is this a good idea? Ken
April 24th, 2008 at 5:05 pm
Hey Ken.
In theory it sounds good, but in reality this is a bad deal.
First, a court would probably look at the situation of you paying $10/month for a $200k piece of land as a “junk note,” like you said. It needs to be fair and reasonable.
Second and most important, even if the structure you set up were to be recognized by the court system, a person suing you could still take your land. Let me give you an example.
Let’s say you’re out on a Sunday drive and you miss a stop sign and hit me. I decide to sue you and take you for everything I can. My lawyer sees that you own an LLC (it’s an asset you own). My lawyer then attaches your LLC to the judgment and if I win, I take control of your LLC.
Now if you’re not the only owner of the LLC (let’s say you and 2 other people own the parcel of land), then I would take control of your % in the LLC in profit earning but would retain no “management” control over it.
Thus, as you can see, the structure you set up for yourself wouldn’t work.
The LLC protects you personally if someone where to get hurt on your land or something of that nature. Then you are protected. If, however, you do something outside of your LLC and away from your land, your assets could be attached to the judgment . . . and guess what, one of your assets is an LLC.
What you need to do to provide full protection and make your LLC and land untouchable is make use of multiple business structures. This would involve knowing your situation a little better to make sure you’re set up with the correct structure.
If you want, use my “Contact Us” link above and choose “Contact John.” Send me a message that you’d like to know what to do and I’ll send you the email address and phone number to my cousin who sets these structures up. If anyone can protect your assets, he can, trust me. Or if you like, send over your phone number in the contact form and I’ll have him call you.
Good luck my friend and great question!
August 1st, 2008 at 7:47 am
the info on LLC was very help. I even learned some new things by reading your article. One question? Are all LLC’s set up the same way? I’m starting a business from home and everything is new to me. right now it’s a sole proprieter but I want to make it a LLC.
August 1st, 2008 at 7:58 am
Hello Karen. I’m glad you found the article informative!
To say all LLCs are set up the same way I hesitate to say only because the series LLC is a bit different, however, for the most part, yup – they’re the same.
An LLC is usually favorable for small to medium business owners starting up and who don’t need to bring in a bunch of shareholders. WP Blog Host is owned by eVentureBiz is an LLC (our LLC name). The flexibility and simplicity in paper work is definitely the big advantage.
If you like, I can have Theresa email you and gather some info from you to help you set up an LLC. She’s quite good and I think you’ll appreciate the price over many other incorporation companies.
Thanks for the comment and stopping by.
September 30th, 2008 at 10:39 am
great article, I learned alot of important things that I did not know. I am planning to joing a friend of mine as a partner in NYC in a construction business. He has been in business for couple of months already. We are not sure how we are going to do this but most probably as a corporation so our personal assets and money would be protected in case of a lawsuit or bankruptcy.
From what I have been reading online most professionals do not suggest a 50/50 split in ownership, why? I am interested in 50/50 split in earnings but would not mind a 49% share but this looks like its no possible in a corporation. In the meantime it would work in a LLC but LLC does not have enough protection I believe.
Any suggestions please?
thank you,
james
September 30th, 2008 at 3:45 pm
Hi James.
Not sure who’s telling you not to do a 50/50 split, I’ve never heard of that and it’s perfectly fine to do a 50/50 split. In a corporation there are shareholders. If you are a two person corp, you each own 50% of shares in the business. Absolutely nothing wrong with that.
Re: LLC Protection
LLCs provide just as much asset protection as a corporation, plain and simple.
If your biggest concern is asset and liability protection, a Nevada corp or llc will provide your company the best protection due to Nevada laws. If you do business in NY, you’ll be taxed according to New York’s tax code, but liability-wise, you company will be protected according to Nevada laws.
Also keep in mind if you’re a contractor, you will have to carry sufficient insurance which is usually a pretty good buffer when someone decides to sue your company.
If you have any further questions, please don’t hesitate to ask and thanks for the comment.
September 30th, 2008 at 4:15 pm
Thank you. This is very helpful. I read online on several websites that did not suggest a 50/50 split because if there is a decision to make in the future and we do not agree on it somebody will have a final say due to a higher percentage of ownership(51%).
re: LLC, I believe a corporation is an entity on its own so that would be better than an LLC. what do you suggest ?
nevada looks interesting with laws regarding the state of business.
thanks again,
james
September 30th, 2008 at 5:01 pm
In that case, however you decide to divvy up your business is up to you. Just make sure you feel confident enough in this other person’s good business decisions to give him total control. Remember, just because someone is good in their trade doesn’t mean they are successful at being an entrepreneur.
Well you have it half right on the LLC part. A corporation is a separate entity all on its own, but so is a LLC. That’s the reason for setting up a “business structure” over being a Sole Proprietor. A LLC, S-Corp, and C-Corp all separate you from your business.
I think you’re thinking of it in the way that a LLC and S-Corp are flow through to your personal income. That is true, but that has nothing to do with asset protection.
Something you might want to consider is how to structure your business based on ownership and profits/income. In a LLC you have great flexibility. You can own 49% of the company while the other guy owns 51%, however, you both split profits equally.
In a corporation, such as an S-Corp, profits and tax liability are divvied up according to ownership. So if you own 49% and he owns 51%, you only make 49% of the profit and are responsible for that amount tax-wise.
Now if you’re starting a major business with lots of employees and such, the C-Corp is probably your best bet.
October 3rd, 2008 at 8:14 am
thanks again John. So lets say me and my partner decide to move forward with a 50/50 share and 50/50 profit split, what if in the future we have a decision to make and we do not agree, who has the final word ?
thank you,
james
October 4th, 2008 at 11:25 am
Hi James. Sorry about the late response – had a family day the other day.
You have 2 options.
When setting up your LLC or Corp, you want to state who has this final say when it’s a 50/50 split on a decision. For the LLC you’d dictate this in your Operating Agreement and in a corporation it’s in the By-Laws.
When we set up business structures for our clients we will set this up for them at no extra charge and if they’re not sure today, by default we include those agreements in their book which they can fill out at a later date.
The second method is to use a separate partnership agreement. SCORE has the general idea and guidelines of drafting one up: http://www.score.org/business_partnership.html
Good luck and let us know if you’d like us to set up a structure for you, our prices are relatively low compared to some companies out there.
October 30th, 2008 at 12:51 pm
I am currently buying a business from someone who has it as a sole proprietorship. At the advice of my friend who is a CPA he has suggested I make it into a LLC. After reading what I have read it sounds like a good idea. We have discussed making him a part of the business in exchange for CPA skills. Nothing he would do full time, but none-the-less it requires time. How do I determine how much of the company to share? Does the amount of % split dictate anything on taxes, or loses?
I obviously would own more of the company since I am purchasing it and would have final say, but under LLC he would be a member without “buying in” or assuming another members part. Im just not sure if that is a wise approach, or better off paying for his services.
November 10th, 2008 at 9:34 am
Hello Rodney, sorry about the late response.
There are different routes you can go as to determining how to split up the profits/shares. Theresa wrote an excellent article called How To Split Business Income Between Partners which you might want to read.
Basically, she says what you could do is create “positions” in your company just like bigger corps do and determine how much that position pays. I’d take a look at % time worked in the business.
As for which route to go (either adding your CPA to the company or just paying for tax services), that’s up to you. Usually though, a small business will just higher out the CPA to do taxes or some other services while larger companies might consider hiring one.
Just make sure if you do decide to put this CPA on your business that they are somewhat passionate about seeing it grow and becoming successful. I’d hate to see you make someone a member and they never really meet your expectations.
January 10th, 2009 at 1:00 am
Thanks for the info, It was very helpful.
January 10th, 2009 at 1:01 am
thanks again
January 10th, 2009 at 4:08 am
My pleasure. Thank you for taking the time to visit
January 17th, 2009 at 11:48 am
Hi,
I am physical therapist- i currently have a full time job and part time job (i contract ,my services to several agencies). a big part of my job is providing services to people’s home and at the agencies site. i have my own professional liability insurance. Im thinking of changing from a sole proprieter to an LLC. I was also reading about PSC- which seems like what i should be under due to my profession. am i bound to just a PSC or can i make turn into an LLC? im not really sure which on would be best in my situation.
Thanks
January 20th, 2009 at 12:11 pm
Hi Nina,
As a licensed therapist you can file for a Professional Corporation, there isn’t really a difference in the workings between a Professional Corporation and a “C” corp, except the “PC has specialized licensed officers.
John has written some very helpful articles on the website explaining a “C” corp and how it works and differs from an LLC.
As a professionally licensed individual you may also form a “PLLC” which is a Professional Service Limited Liability Company”. This gives you the advantage of forming an LLC which is the best structure for asset protection purposes.
In answer to your question you are not bound by any law to be a “professional” corporation or LLC. Thanks again for contacting us, just let me know if we can be of any further assistance you.
John Hoff’s last blog post..Understanding The Psychology Of Your Website Visitors
February 5th, 2009 at 2:26 am
Hi John & Theresa,
Loved your articles they where well written and quite informative. They were able to erase some misconceptions I had about the types of business structures, and now I have a few questions and I hope you can point me in the right direction.
I am going to start 3 businesses within the next month or so, and will be employing about 124 employees in total. I have an umbrella company and two other separate entities.
I already have the funding necessary to do so, therefore I’m not currently looking for investors, however after reading your article John, I’m leaning towards a C corp because of the protection, future growth potential and the write-offs benefits it provides.
First question, can I form a C corp by myself or do I need partners/members, and do they have to be shareholders even though they didn’t invest into the company?
Second question, one of the project I am establishing is a not-for-profit entity, and I would like to purchase the property in my name or even the umbrella company’s name and let that entity pay “rent” to me or the company. I’d like to know how should I protect the properties from any potential lawsuits that I or even my company might face?
Next question Theresa, how do I go about controlling everything but own nothing so that no one can get any of my assets if they sue? Should I place it in a Living Trust for my child or is there another method?
Finally, could you send me a fee schedule for establishing a business structure as well as Living Trust?
Thanking you in advance for answering my questions and putting me on the right track.
Looking forward in hearing from you both soon.
February 7th, 2009 at 7:47 am
Great article. The tables with the red arrows do a great job of conveying the benefits / differences of each type of corporate entity. Good summary of the advantages of Nevada incorporation as well.
bill’s last blog post..Incorporate as an LLC, S-corp, or C-Corp ?
March 11th, 2009 at 3:14 am
Is this still available?
March 11th, 2009 at 7:18 am
Hi Designer Jewellery. We still provide incorporation services if that’s what you’re referring to. Head over to our incorporation services page for more details and send us a note. We can help you get structured.
August 30th, 2009 at 12:25 am
Hi,
Thanks for the article I found it very informative. My wife and I have a partnership at the moment, that we would like to incorporate for protection. I also do some consulting on the side. If I start an LLC for the consulting, and a separate one for our current business (and any other business that may come down the line), can we place them all under an umbrella corp? Does this have to be a C corp or can I place them under an LLC or S corp?
Thanks
December 20th, 2009 at 11:04 pm
Hi John,
I am looking into starting my own car rental business soon and I was wondering if LLC was best for me, or a c corp? I want to try to run it from home until I can afford an office space. I live in California but I like the advatanges of Nevada Corporations. I read in your article that you can incorporate your business in Nevada and register your new corporation in your state of business. I dont quite understand it and would really appreciate it if you could help me understand it more.
Thank you,
Janelle