Being an entrepreneur is a dream for many people. While few step-out of the comfort zone by leaving their jobs, whereas few people consider the situation as fate and never try to take a risk. We don’t say the process of setting up a business is easy. It is no doubt tough as hell, and many barriers will be waiting as you complete one work after other.
Setting up a business needs investment. If you have investors or you are the source of investment, initial problems can easily be solved. There are legalities to go through for proper paperwork and representation of the company in society. Protecting your business is the first and most important factor to focus on. A Legal structure is one where the company applies that specific legal structure and follows the rules and guidelines as described.
Limited Liability Companies (LLCs) and S corporations (S-Corps) are the legal structures available in the United States for entrepreneurs. People have to select one of them and apply to their businesses. Both LLC and S-Corp have own set of advantages and disadvantages. Let us understand what exactly are LLC and S-Corp and why are they so important and advantageous to use for entrepreneurs.
S-Corp and its advantages
S-Corp offers liability protection for the owners of the business. Liability protection refers that all the personal assets of owners should not be considered for repayment of loans or debts. Even if business gets losses, at least banks or financers cannot come for personal assets as a replacement.
Pass through taxation is another advantage linked with S-Corp. In general, taxes are paid at individual levels and as a company owner. This results in double taxation as more money is used in the form of taxes. But under S-Corp legal structure, there will be no separate tax payments. The profits and losses will be for the owner, and the taxes are to be paid at the individual level rather than paying both personal and corporate tax.
Shareholders are equally important and considered owners of a business. S-Corp only allows 100 shareholders for a specific business. All the profits and losses must be shared among the shareholders and tax is calculated at an individual rate. In short, all shareholders will receive a monthly salary for their contribution at primary level. As discussed above, profits and losses are also shared by them.
The first disadvantage is that only US citizens can opt for S-Corp legal structure. Foreign people can only go with LLC as there are no alternatives available. One more drawback is that there is a limit for shareholders. According to S-Corp guidelines, 100 shareholders are only eligible for a company. Each owns only one stock, and this raises a problem for investors.
For company expansion, if a requirement comes for more shareholders for investment, it is not possible under S-Corp legal structure. Additional taxes may get imposed onto owners in other countries. A company in order to become successful needs expansion to multiple cities to increase the business.
LLC and its advantages
LLC and S-Corp are most used legal structures in and across the US. Just like S-Corp, LLC also offers liability assets protection of owners. Pass through taxation also exists in LLC but in a different way of execution. In S-Corp, owners will pay themselves salaries and profits/losses are shared between them.
Tax is applied on an individual level, and there is no separate personal tax and tax on business income. In LLC, there is no system for paying salaries to owners and all as S-Corp. Here all the expenses and income comes under one roof and is reported as personal income tax returns. LLC is easy to set up as compared to S-Corp.
The pricing is also cheaper as it only takes about few hundred dollars to register a new LLC. As we know in S-Corps, only US citizens are eligible, and shareholders must also be from the US, but in LLC, there are no such restrictions.
Non-US citizens, corporations, trusts and basically anyone can set up a business and register under LLC legal structure. In S-Corp, shareholders have to take salaries, whereas profits and losses are equally shared between them. There is no such rule in LLC for distributing salaries among shareholders. LLC is tax efficient. Business owners can entirely avoid double taxation and dividend taxes based on the individual and location of the company. But be careful before setting up office branches in countries as their laws may recognize LLC structure or not and take suitable actions.
As the owners need not take salaries in LLC, he/she has to pay self-employment tax. We are opting for legal structures for legal protection of the company. But there is a chance to lose the protection of liability assets if the process of registration is not followed as per the official rules and regulations.
Just like for S-Corp, some countries don’t recognize LLC structure. People may experience double taxation and many other issues if not followed guidelines.
LLC or S-Corp – Which one is better?
LLC and S-Corp legal structures are better in their own aspects. Selecting only one of the two will be difficult. But individuals, based on the business and location of the company, can choose either LLC or S-Corp. As we know, S-Corp will not work for people outside the US. So, foreign people who are planning to set up a business may consider LLC.
Residents of US, based on their business, can analyze the pros and cons of both LLC and S-Corp legal structures and can decide on one among them. As both are good in some aspects and give loss in some aspects, we cannot judge directly.
Legal structures are indeed essential for the protection of business. Along with security, they provide tax benefits also. So, why not opt for them and enjoy those benefits? Yes, it is true that both LLC and S-Corp have advantages and disadvantages.
But this depends only on the scenario. Among the two, analyze and apply both legal structures to your business and see what suits best. Follow that specific legal structure to get most benefits.