Posted By Larry on September 20, 2009
If you’re a small business owner and you operate in your own capacity – in other words, as a “sole proprietorship” – you are personally liable for all of the debts and obligations of the business itself; if your business fails, you go under with it. But even if you’re willing to create an artificial entity through which to run your business, where do you start? What entity do you create?
The two structures most conducive to small businesses are Limited Liability Companies (LLCs) and Subchapter “S” Corporations (S-Corporations). The LLC is a relatively new business entity that affords its owners the operational flexibility of a partnership, along with the protection against personal liability for debts of the business, which is characteristic of a Corporation. The S-Corporation is a “closed” Corporation with few shareholders that enjoys various tax benefits. Depending on your situation, one or both of the structures may not be available to you – or one might be more beneficial. If you’re contemplating the creation of an artificial entity through which to conduct your business activities, you should consult with an attorney experienced in Florida Corporation/ business law.
In the meantime, here’s a quick rundown. Both LLCs and S-Corporations feature “pass-through” tax structures, which means that their income is passed through to their owners, thus eliminating the double taxation incurred by owners of standard Corporations. Nonetheless, if employment tax benefits are your primary concern, you should consider forming an S-Corporation; alternatively, if you’re primarily concerned about maintaining flexibility in the management of your business, you’d likely be happier with an LLC.
Just to give you an example of the pros/ cons for each entity –
As to the S-Corporation:
- Self-employment tax flexibility since not all revenue is considered income and therefore some revenue can be distributed as profits instead of as salary.
- Restricts who can own the business, in that the S-Corporation form is not available if there are more than 75 shareholders or if any potential shareholder is a non-resident alien.
- Requires adherence to sometimes burdensome corporate formalities, including strict initial formation guidelines, mandatory annual director and shareholder meetings, complete documentation of corporate decision-making processes and periodic filing of records with the Florida Secretary of State.
- Does not provide for any flexibility regarding income or profit distribution.
As to the LLC:
- Allows for flexibility related to self-employment tax; the self-employment tax for 2009 is 15.3 % for social security, 2.9 % for Medicare.
- There are fewer restrictions as to who can own the LLC.
- Although you must adhere to some formalities regarding the formation of the LLC, etc., it is not necessary that formal meetings be held annually, and business documents need not be scrupulously maintained or filed with the state.
- Allows for flexibility regarding distribution of income and losses; in other words, a shareholder/owner may be compensated more or less than the worth of his share in the business, so that a “manager,” for example, can derive more profit for his contribution in running the business.
All in all, you must evaluate the pros and cons of each entity as applied to your particular situation. And know that regardless of which entity you choose, you will be required to complete some paperwork, which, if left incomplete, could nullify the protections of entity status. So tread carefully!