DETERMINING IF A S-CORP OR LLC IS RIGHT FOR YOU
By Stefanie L. Brown
Given the current state of the construction industry and the increased level of risk that contractors appear to be facing, most contractors understand that they should be operating their business as an entity. Using a business entity can afford great protection of your personal assets, like your home, car, and personal savings accounts, in the case of a claim by a homeowner. It’s important to understand that any form of business entity that provides liability protection requires additional administration. This includes the requirement that you keep your personal finances and business finances completely separate, filing all appropriate forms with necessary governmental agencies, and maintaining separation between your personal assets and business activities. Once you conclude you need an entity, the most common question I hear is “What is the difference between an LLC and S-Corp?”. These entities can look nearly identical, but they can also have very crucial distinctions.
An S-Corp is the more traditional business entity. It has a traditional corporate structure, which means it is managed by a board of directors, and officers such as the CEO and CFO. The S-Corp is formed by filing Articles of Incorporation and annual renewals with the Secretary of State each year to keep the S-Corp in good standing. The S-Corp requires annual meetings of the shareholders and directors (which can be held in a way that is convenient and informal) in order to elect officers for the next year and to review the financial condition of the corporation. The S-Corp is also required to submit an Application for an S-Form Election to the IRS. While the S-Corp is more formal than an LLC, a small company may still utilize an S-Corp.
The LLC was designed to be something of a partnership and corporate hybrid. It is a very flexible business structure that provides multiple options to the company’s owners. It may be either manager-managed, by directors and officers (similar to an S-Corp), or member managed, meaning the actual owners are collectively making the decisions of the company (similar to a partnership). The LLC also requires the initial filing of the Articles of Organization with the Secretary of State, and annual renewals.
Both LLC’s and S-Corp’s pass through tax entities, which means all of the income of the company is reported on the tax returns of the owners. Both provide excellent liability shields to ensure that only the assets of the business are available to creditors bringing claims against the company in most circumstances.
By now you are probably asking, “Which is better?” The definition of “better” depends on the objectives and characteristics of your business. The advantages of an S-Corp are that it is more commonly recognized in many industries. The construction industry was previously dominated by S-Corp’s, based on everyone’s familiarity with that structure. Many suppliers and financers felt more comfortable working with S-Corps. Similarly, S-Corp’s have more history, case law and a background in IRS regulations, which helps to determine the legal outcome in various situations. The advantage of an LLC is that it has a less formal structure, and management can be tailored to your particular situation. The LLC has become more popular based on its low maintenance style; therefore, it has become much more acceptable in the industry over the past several years.
One of the main considerations in determining which type of entity to use is tax consequences. Before forming either of these entities, I would advise that you work with an accountant to look at the potential tax advantages or disadvantages and an attorney to look at the potential legal aspects of forming either an LLC or an S-Corp. An S-Corp has the potential for tax benefits if the shareholders pay themselves salary. Similarly, there are tax considerations for using an LLC when purchasing parcels of land intended to be transferred prior to development. Both the S-Corp and the LLC offer distinct benefits, and if you are considering either of these entities, you should carefully analyze what type of business setup is right for you.
© 2007 - Stefanie L. Brown and Rinke Noonan Law Firm, St. Cloud, Minnesota Stefanie L. Brown is a member of the Rinke Noonan Business and Transaction Department. She has extensive experience working in the corporate, real estate, and residential construction field.
©2007 - Stefanie L. Brown and the Rinke-Noonan Law Firm
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