LLC vs. Subchapter S

LLC vs. subchapter S refers to the difference in structure between a limited liability company (LLC) and a subchapter S corporation (S corp).

Corporate Structure

Small businesses and start-ups form companies often as an LLC or as an S corp (which is different than a C corp). The purpose of this is to provide protection to the members (LLCV) or shareholders (S corp).

LLCs are created by state law. Each state has rules for the creation and operation of LLCs. Some states are better than others for this.  c

Sole Proprietorships

Another common business structure is a sole proprietorship. If the whole organization is run by one individual, who is also responsible for liabilities, assets, and operations, then that is a sole proprietorship. You are automatically a sole proprietorship if you have no partners and haven’t set up any other legal structure for your business. The biggest drawback to this business organization is that it doesn’t provide any protection for your personal assets if the business has debts, legal obligations, or loses a lawsuit.  

One of the things that many advisors will tell a sole proprietor, to separate personal and business assets.

General Partnership

General partnerships are almost exactly like a sole proprietorship except they have two or more partners.

While partners have dual control over many aspects of the business, their actual agreement will provide the architecture for how decisions will be made and how the business will be managed.

Similar to a sole proprietorship, in a general partnership, you must acquire local licenses and register the trade name with the Secretary of State. A written partnership agreement is highly recommended to avoid disputes and misunderstandings among the partners. In the pursuit of raising money for the business, general partnerships are not ideal. Investors become partners when they “buy in” to the business. Partnerships, like all relationships, evolve and change. The partnership agreement may allow for some flexibility.

Limited Partnerships

A different type of partnership (from a general partnership) is a limited partnership. Limited partners are investors but do not participate in the running of the business.

Partnership agreements are even more important in a limited partnership. The agreement is necessary to lay out the rights and responsibilities of both the general and limited partners. The structure of a limited partnership lends itself to raining money more easily because investors can become general partners without assuming any of the businesses liability or having to work in the business.

Limited Liability Company

A limited liability company has the best of corporations and the best of partnerships.

Articles of organization are still required for an LLC with the state in which the company will be formed. In addition, formation must be announced in a local newspaper.

C Corporation

A C corporation is a company that is owned by shareholders.

If a business has an eye toward becoming a public company in the future, a C corp is a good fit for their corporate structure. This is also a good structure for businesses that need to raise a significant amount of money or where there is a lot of liability. This structure protects shareholders from personal liability.

While this protection extends to owners when the company is sued, it does not extend when there is negligence, fraud, or misconduct.  When these things occur, a court can “pierce the corporate veil” and hold individual shareholders responsible for the legal obligations of the company. One drawback is that C corps are taxed both on income and on shareholder disbursements.

LLC and S Corp Taxation

All businesses are taxed on net profits which is the result of taking income (through sales) and deducting expenses (as allowed by the IRS). The LLC member is personally taxed on this amount. An S corp, on the other hand, pays a salary to a working owner of the business. That salary is deducted from the profits of the organization before it flows to the owner’s personal tax return. Profits, therefore, are not subject to Medicare and Social Security taxes and the owner will only pay those on the salary.

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