Over the last few weeks on the blog I’ve attempted to explore some of the differences between an S-Corporation (S-Corp) and a limited liability corporation (“LLC”). The point of this examination is to aid entrepreneurs better understand when it is appropriate to use one form of legal organization as opposed to the other.
Unfortunately, it is difficult to summarize the differences between an S-Corp and an LLC or to propound a simple over-arching rule. When you go to law school a major part of the training you receive is learning how to identify and distinguish between different situations, cases, or fact patterns. Each situation, we are trained to think, presents a unique set of facts and thus we learn to apply rules differently depending on the facts at hand.
So it may be easy for me to explain why with a particular set of facts, an S-Corp is preferable, or with other facts an LLC seems better, and yet it is much more difficult to offer up general guidance.
General guidance is precisely what most clients really want to hear.
“For every complex problem there is an answer that is clear, simple, and wrong.” – H. L. Mencken
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S-Corp and LLC are both well suited to achieving the major objective of limiting tax exposure for a newly founded entity (as we explained in a prior blog post here). However, each form of entity has a few technical differences that also must be considered.
For entities based or doing business in New York City, there are various factors which may tip the scales in the balance one way or the other, such as the additional costs associated with the publication requirement imposed on LLC’s in New York City, or the incremental 8.85% tax burden on S-Corp’s that are based in or earn income in New York City, compared to a lower 4% rate faced by LLC’s based in New York City coupled with the self-employment tax burden on entities.
The comparative benefits of an S-Corp vs. an LLC is further complicated when other issues are considered, such as the protection in liability afforded to an S-Corp or LLC from claims against their shareholders or members, as the case may be. An S-Corp is a legal corporation (with a special election as to taxation) and, as such, it benefits from the long history and tradition of limited liability well established under state law. Corporate shareholders are not liable for the debts of the business, generally, nor are corporations liable for the debts of their shareholders. New York law accords Limited Liability Companies similar protection to a Limited Liability Company with respect to the debts of its members, though that protection is done through analogy, not directly through case law.
That being said, the Member of an LLC can have their interest subject to a lien on distribution, and foreclosed upon.
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Explaining all these technical differences probably does not make it any easier for an entrepreneur to understand when it is better to use an S-Corp instead of an LLC. Instead, it may make your head spin and for you to be glad you never went to law school.
If you are an entrepreneur struggling with this issue, I want to offer the following observation. (Please note – this is not offered up as advice since the cardinal rule of legal blogging is never to offer any sort of legal advice on your blog!) My observation is this:
perhaps you are asking the wrong question
There may be a much more useful series of questions for you to ask yourself as you go about deciding what sort of entity you want to create for your next venture.
Instead, here are a few questions you might want to start with:
- How many shareholders will your new venture have?
- Will all the shareholders be people?
- Are all of the shareholders at least resident aliens or citizens?
- Will your new venture require more than a simple capital structure?
These questions are key in choosing between an S-Corp and an LLC. These questions may result in a very simple choice after all because in many situations there may be no choice at all.
As we discussed previously, an S-Corp election imposes certain limitations on who can be a shareholder (no nonresident alien as a shareholder and usually, only people, not entities), and how many shareholders a corporation electing an S-election (100 shareholders only), and, perhaps most significantly, on there being only one class of stock. If the new entity you want to create runs afoul of any of these limitations then the matter is settled.
And if not, please feel free to give me a call or send me an email, and I will be glad to discuss the facts of your own situation with you further.