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Should You Choose an S Corporation or an LLC

By Lane V. Erickson, Idaho Business Attorney

You want to start a business and you’ve read or heard from well-meaning friends or family that you should set up an LLC. Then you read an article on the internet or other friends or family tell you that you should use an S-Corporation instead. Because of your confusion you talk to an accountant who tells you that there are advantages and disadvantages to each one. They may start talking about pass-through taxes, or organizational requirements or the filings that have to be made with various state and federal agencies. When you are done with all of this you are more confused than ever about what you should do.

Don’t panic. We can help. At the Racine law office our team of experienced Idaho business attorneys understand the importance of the decisions that are made when a client is starting a business or changing how the business is operated. We have helped numerous clients understand and make good decisions about their corporate structure for more than 70 years. Our attorneys are knowledgeable and skilled in helping business clients deal with all of their business needs. We are confident that we can help you too!

The purpose of this article is to provide some simple explanations about the differences between an LLC and an S corporation. This article is not designed to be exhaustive, however. Because of this, we recommend that you speak with a qualified Idaho business attorney who can help you make a knowing and meaningful decision about what type of business entity you should create for your business.

Protecting Business Assets

To start off with, let's talk about some of the things that make an LLC and an S corporation similar. Both business entities are designed to provide specific protections for the assets of the company. Additionally, both entities are designed to provide protection to the owners’ assets outside of the business.

Each of these entities is entitled to be protected by the corporate shield. This is a fancy way of saying that the liabilities that occur in the business will remain in the business and not go beyond the business to the owners’ individual assets. Likewise, if one of the individual owners has liabilities that arise outside of the business, those liabilities don't directly affect the operation of the business because of the corporate shield.

Based on the fact that both LLCs and S corporations are entitled to the protection of the corporate shield, this really doesn't answer the question of which one would be best for you and your business. However, this is the best place to start because it helps you understand that both entities are designed to provide these protections.

Management and Decision Making

Things do become a little different when it comes to management of the business. An LLC is managed by either all of the members or owners of the business, or by specific person the owners designated as the managing member or manager. This person is usually tasked with the responsibility of taking care of the day-to-day operations of the business.

In contrast, an S corporation is controlled by its board of directors. The board of directors can elect to hire a president, or other type of manager or management position, to control the day-to-day operations of the business.

With each of these entities, the decision-making ability is controlled by the corporate documentation. For an LLC this would be the operating agreement which would designate who the managers or manager would be. When it comes to an S corporation this would be bylaws that would control the board of directors and the powers given to the board of directors to decide who will be placed in management of the business.

Taxes

We really start seeing a difference when it comes to taxes. An LLC is treated similar to a partnership. As a result, an LLC is used as a pass-through entity. This means that any profits or losses that occur in the business are passed through to the owners of the business.

This passed through of profits or losses is identified on a specific tax document called a schedule K-1. This document is given to each one of the owners. This document designates the percentage of gains or losses each owner is entitled to in the LLC. As a result of this percentage, the loss or gains attributed to the LLC are given to each individual member based on what is reported. This percentage may not specifically be tied to the percentage of ownership of the LLC. As a result, an LLC member could own 50% of the business but be entitled through the operating agreement to 90% of the profits or losses.

Typically, all of the profits that are designated on an LLC schedule K-1 are subject to self-employment taxes. In other words, the IRS is going to get its fair share from you even if the money you received from the LLC was not received as an employee but rather as an owner.

Things are a little different when it comes to an S corporation. In this instance S corporations could have preferable self-employment taxes compared to what an LLC does because the owner of an S corporation can be treated as an employee and paid a reasonable salary. When this occurs, FICA taxes are withheld and paid on that amount. After this, the remaining corporate earnings may be able to be treated as unearned income that is not subject to self-employment taxes. S corporation owners typically receive their profits and losses based on their specific percentage of ownership of the business. As a result, if a person owns 30% of the business, they will typically receive 30% of the profits or losses.

Ease of Operation

With regards to the ease of operation of LLCs and S corporations, there are some differences. In many instances, LLCs are much easier to operate because there are far fewer formalities associated with LLCs than there are with S corporations.

The required formalities for an S corporation often include adopting and updating bylaws, issuing specific stock for ownership of the business, holding initial and annual director and shareholder meetings, and keeping written meeting minutes and other corporate records within the business.

While many of the same things are suggested or encouraged for LLCs they may not necessarily be specifically required based on the applicable law. Even if an LLC does not adopt its own written operating agreement, the default operating agreement set forth in the statutes in Idaho will apply. Additionally, while it's important to hold regular meetings between the owners of an LLC there is no specific requirement that this be done.

For many small businesses, an LLC seems to be the right entity to use. However, this will depend on a number of things including whether there will be outside investors infusing money into the business, how many owners are associated with the business, the purposes of the business, and the long-term outlook of the business itself.

For these reasons, if you’ve begun a small business or you were thinking about doing so and you are confused about whether you should use an LLC or an S corporation as the business entity, we can help. We encourage you to meet with us so we can discuss these differences in more detail and give you the information you need to make a meeting for decision about your business. We have helped numerous clients create each of these various types of business entities and we are confident that we can help you too!

Enlist an Idaho Business Attorney to Help You

Our team of Idaho business lawyers can help you with any of your business structure or operation needs. Whether you are seeking to create a new business or review a current business, we are available to discuss your options and answer your questions at an initial free 30-minute consultation. Call us toll free at 877-232-6101 or 208-232-6101 for a free consultation. You can also email us directly at lane@racineolson.com or stop by our office at 201 East Center Street, Pocatello, Idaho 83201. We will answer your questions and help you solve your Idaho business problems.

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