Law News and Tips

LLC or S Corporation

Fred Vilbig - Thursday, October 30, 2014

When someone comes in to talk to me about starting a new business, the question that inevitably comes up is whether they should form an LLC or go with an S-Corporation. I wish the answer were a simple one, but it is a little involved.

I tend to shy away from corporations now. Too much reporting and too many meetings. Under Missouri law (but I have found that this is similar to the laws of other states), you have to file articles of incorporation. You have to adopt bylaws. Generally, you have to have a board of directors, although with certain closely held corporation forms, you can dispense with that. The board must elect a president and a secretary, at least. Each year, you have to file annual reports with the State telling them who your officers and directors are. And then you need to have annual meetings of the shareholders and directors, which most small businesses neglect to do until an emergency comes up.

With an LLC, you file articles of organization (again, this is pursuant to Missouri law, although I believe that most states have similar provisions). Then you must execute an operating agreement. Then you’re done. Yes, you can make this more complicated, but that is the end of your legal requirements. So an LLC is simpler.

Then there comes the question of taxes. If you are taxed as a sole proprietor or a partnership, all of your earnings are subject to the federal self-employment tax, which is currently 15.3%. That’s a bad thing.

If, however, you opt to be taxed as a corporation and file an election to be treated as an S-corporation, with proper planning, you can avoid the self-employment tax on amounts in excess of a reasonable salary for your job. But the interesting thing is that you don’t have to be a corporation to opt to be taxed as a corporation and file the S-election. You can do that as an LLC. So you have the simplicity of an LLC for operations and the tax savings of an S-corporation. That’s a good thing.

The problem is that the S-election brings with it some additional paperwork. As a sole proprietor, you report all of your income on the Form 1040, Schedule C (you also have to file a Schedule SE). With a partnership, you have to file a Form 1065. With an S-Corporation, you finally Form 1120-S, and you’d have to file a periodic employment tax return.

My suggestion is always to discuss this with your accountant. If you think that your business operation is going to be more of a hobby than a big money maker, maybe the simplicity of a sole proprietorship or a partnership is better for you. However, if a new entrepreneur realistically thinks he or she is going to make more money than what would be a reasonable salary, then the S-election route should be seriously considered with the accountant.

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