Subchapter S LLC: Everything You Need to Know
A subchapter S LLC is a business formation that combines elements of an S corporation with those of a limited liability company, or LLC.3 min read
LLC Electing S Corp Status -- The Best of Both Worlds
For new business owners or those who are considering changing the structure of their business, one of the most common first steps is comparing S corporations to LLCs.
Many entrepreneurs, accountants, and attorneys will debate over which business formation is best between the S corporation and the LLC. However, business owners don't necessarily have to choose between the two. A subchapter S LLC is a business that has been formed as an LLC and elected for taxation and treatment as an S corporation.
An LLC is a unique type of business formation that is governed by state laws. Each state has its own set of statutes that outline the rules of creating and operating an LLC. An S corporation, also called an S corp, is a corporation that is formed under state laws and files taxes under the United States IRS code, Subchapter S. An S corp isn't a specific business entity, but a tax filing status with the IRS.
If an LLC has high SECA or payroll taxes on the owner(s) and operates an active business or trade, electing for taxation as an S corporation may be beneficial. Both LLCs and S corps are pass-through organizations, which means the profits and losses are passed through the business to the owner(s). Another similarity is that both are formalities mandated by state laws and requirements, including paying any required fees and filing reports every year. Both offer limited liability protection to the business owner(s).
New business owners should look at the differences between LLCs and S corps to determine which formation is the best option.
- An LLC is easier to form and operate than an S corporation.
- An LLC is more flexible than an S corporation for allocating losses and profits between the owners.
- An S corporation makes it easier to plan for taxes than an LLC.
- An S corporation is more flexible in how the allocations to owners can be made, such as in the form of distributions or as earned income as wages or salaries.
You might choose one or the other, or you might elect for elements of both, but you should start by deciding which features are most critical to your business and its owners.
Differences in Ownership and Formalities
One of the main differences between S corporations and LLCs is restricted ownership. An LLC can have any number of owners, called members, while an S corporation is limited to a maximum of 100 owners, called shareholders. S corporation shareholders must be United States citizens and/or residents, while LLC members don't have to be citizens or residents. An S corporation can't be owned by a C corporation, partnership, another S corporation, or most types of trusts, but an LLC can be owned by another business, regardless of the formation.
An LLC can have subsidiary LLCs without any restrictions. An S corporation is subject to additional formalities, while an LLC doesn't have those same requirements. Some of these S corporation formalities include:
- Holding an initial director and shareholder meeting
- Holding annual shareholder and director meetings
- Issuing stock
- Maintaining minutes at all required meetings in the corporate records
- Adopting bylaws
Although these formalities aren't required, they are recommended for LLCs:
- Documenting any major business decisions
- Adopting an operating agreement
- Holding annual member and manager meetings
- Documenting the annual meetings
- Issuing shares of membership to each member
LLC members can choose between a member-managed and manager-managed organizational structure. If the members of an LLC choose to manage the day-to-day operations, it will operate similarly to a partnership. A manager-managed LLC is more similar to a corporation in terms of daily operations since the members aren't involved in small decisions. An S corporation must have a board of directors, which is responsible for overseeing all corporate affairs and handling crucial decisions, as well as officers.
The existence of an S corp is perpetual while an LLC, in some states, may be required to include a date of dissolution on its formation documents.
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