The S-Corporation has become one of the most popular business structures in America, with over 3 million small businesses incorporated as S Corps and/or filing taxes as S Corps. Many entrepreneurs love the flexibility and tax advantages that go with this choice of business structure.
However, the S Corp has certain complications and drawbacks as well. Depending on your business, you might not need or want the extra levels of details and “hoops to jump through” that go with incorporating as an S-Corporation.
Here are a few questions to consider if you’re trying to decide between incorporating as an S-Corporation or simply forming an LLC:
- Do you want a Board of Directors? When you incorporate as an S-Corporation, you generally have to file Articles of Incorporation and name a Board of Directors (some rules vary depending on the state where your business is located). There are more complications involved with incorporating as an S-Corp, instead of merely setting up your company as an LLC. S-Corps are also subject to more formalities and business filings, such as adopting bylaws and issuing stock, hosting annual shareholder meetings and keeping the meeting minutes on file as part of the company’s records for compliance purposes. If you’re a solo entrepreneur, then you might not want to put up with the extra hassles of appointing a Board and dealing with the ongoing business filings that are required to form an S-Corp. Doing business as an S-Corp can offer certain tax advantages compared to an LLC, but there are “strings attached.”
- How many partners do you have, and who are they? If you’re a sole proprietor or part of a small partnership (with only 1 or partners), then an LLC might be the best choice to incorporate a business, since the LLC does not require as many formalities and filings. If you have a simple business with a smaller number of people involved, you might not need the extra complications of having a Board of Directors and adding new business filings throughout the year. However, if you have multiple partners, an S-Corp might be the best choice. Under IRS rules, each S-Corp can have up to 100 partners (and married couples count as a single “partner”). There are restrictions on who can be a shareholder in an S-Corp – S-Corp shareholders must be U.S. citizens, which means that if you have business partners located in other countries (or born in other countries), incorporating as an S-Corp is probably not the best choice for your business.
- How flexible do you need to be in apportioning income? LLCs and S-Corporations both have “pass through” taxation as a helpful feature (meaning that the company itself does not pay income tax) but one big difference is that with an S-Corp, income can only be apportioned based on the partners’ share of ownership of the company. So if one partner owns 80% of the stock, that partner gets 80% of the company’s annual income. An LLC offers greater flexibility to dole out income among the various partners – so if you want to reward a partner for extra effort, or give a junior partner a larger share of the company profits as a bonus, you can do this more easily with an LLC than with an S-Corp.
NOTE: CorpNet does not give tax advice and this article does not claim to do so. Please consult with a professional tax adviser before making any final decisions about whether to incorporate as an S-Corporation (or other corporate entity) and how to handle your corporate and personal income tax liabilities.