Should a home-improvement company be structured as an S-corp. or an LLC? Experts say choosing a form of business ownership depends on several key factors, including tax concerns, potential risks and business liabilities, desire for flexible management structure, and future investment needs.
Corporate ownership of a business shields the business owner from direct risk and liability.
The LLC — limited liability corporation — stands midway between sole proprietorship and partnerships, on the one hand, and corporations, which are governed by hard and fast rules. “The main reason for incorporating is the liability protection it affords,” says Dan Bawden, an attorney and owner of Legal Eagle Construction, in Houston. “Both the LLC and the S-corp. give you that shield, from a liability standpoint.”
LLCs, which emerged in the early '80s, meld the “pass through” taxation features of partnerships or sole proprietorships with the protections from liability afforded by corporations. In LLCs, profits generated by the business pass through as income to owners (“members”), who pay personal income taxes on it (or can deduct losses). All LLC profits are taxed, regardless of whether or not they're retained. S-corp. owners, on the other hand, pay personal taxes on salaries, bonuses, and dividends paid to them, while retained corporate profits are taxed separately at a lower rate.
Additional advantages of the LLC have to do with flexibility. S-corps. are set up and governed in prescribed ways, i.e., they must have a board of directors, a president, and a secretary. LLCs offer owners greater flexibility in management structure and distribution of profits. (An LLC can be managed by members or managed by a board.) There are no restrictions on who can have membership in an LLC, including corporations.
California CPA Steve Maltzman suggests that those considering LLC vs. S-corp. ownership keep in mind “how large, and how sophisticated, you want to be.”
S-corporations are good for owners who at some point may want to take their companies public or switch to an Employee Stock Ownership Plan (ESOP).