The Difference Between an LLC and a Subchapter S Corporation
Startup businesses are often considering either a Limited Liability Company ("LLC") or a Subchapter S Corporation. Here are the differences:
The primary reason to have an LLC or a Subchapter S Corporation is to limit the members' liability. The members are similar to partners in a partnership. Unlike a partnership however, a single member can form an LLC. To form an LLC the entity will need to be registered with the State. In Connecticut, this is with the Secretary of State. There is an additional requirement to register with the Department of Revenue Services. If this business will have employees, it will also need to register with the Department of Labor.
An LLC is not a taxpaying entity. The profits and losses 'flow through' to the members. They will be taxed on their profits. Profits and losses are reported on Form 1065, Schedule K-1. As such, the members in an LLC do not have any income taxes withheld at source. They will need to file and pay federal and state estimated taxes every quarter.
An LLC is more flexible than a Subchapter S Corporation. While the LLC can provide more flexibility than a Subchapter S Corporation, many startup businesses should take a hard look at an S Corporation. Paying estimated taxes every quarter requires discipline, which is not something all taxpayers have.
Subchapter S Corporation
The first step is to elect Subchapter S filing Status. This is done on Form 2553. Caution needs to be exercised when completing this form. You will first need to determine that the entity is eligible to become a Subchapter S company. The requirements are:
- The company is a domestic corporation
- It has no more than 100 shareholders
- It's only shareholders are individuals, estates and certain exempt organizations
- It has no nonresident alien shareholders
- It has only one class of stock
- It will usually adopt a December 31 year end
All of the shareholders must sign and date the Form 2553. As with all correspondence with the tax authorities, we suggest it is mailed certified mail, return receipt requested, for proof of filing.
If you are eligible to form a Subchapter S Corporation ("S Corp.") the entity will first need to be incorporated. Have your attorney get you registered with the State.
If a stockholder is active in the business, it is likely they will become an employee. As such, they will receive a W-2 with the attendant tax withholdings. A Subchapter S shareholder will also receive an 1120S, Schedule K-1, which will report their respective profits and losses.
A Subchapter S Corporation is much more rigid than an LLC. Profits are split among shareholders on a pro-rata, per share basis.
ACTION ITEM: Startup business owners need to know the difference between an LLC and a Subchapter S Corporation.
Thomas F. Scanlon, CPA, CFP®
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