What are some differences between S-Corporations and Limited Liability Companies?

When starting a business, one of the first decisions to make is what type of business entity you should form.  While there are other options, this decision usually comes down to whether to form your company as a S-Corporation or as a limited liability company (LLC).  While both of these types of entities provide protection for the business owners, there are several factors to consider, and many differences between the two types of companies.

One factor to consider is the amount of legal and administrative requirements.  In general, a LLC requires less legal paperwork, and there are fewer filings required.  A LLC must have an operating agreement, which governs the management of the company, and the members rights and responsibilities.  Corporations must have bylaws, articles of incorporation, and a shareholders’ agreement.  Corporations must also hold regular shareholders’ meetings, and must keep minutes of such meetings.

Another factor to consider is the distribution of profits of the company.  In a LLC, the company can establish preferred distributions to certain members, so that they can be compensated at a greater rate than other members.  This can be used to pay back investors more quickly, or to compensate members for their working contributions to the company.  In a S-Corporation, distributions of profits must be made in the same proportion as the ownership percentages of the company.  That means that a company cannot make preferred distributions to specific shareholders in a S-Corporation.

There are also many tax considerations to consider when choosing your company’s entity.  While LLCs and S-Corporations both use what is referred to as “pass-through taxation,” (where revenues are “passed” directly to the personal income tax of interest holders rather than to the company so there’s no double tax), there can be some significant differences between the two forms.  It is best to discuss the tax implications of choosing a company with your accountant, and to consider that factor along with the other relevant issues.