I get asked frequently about Limited Liability Companies (LLC) vs Sub Chapter S Corporations, particularly when it comes to small business and start ups. Here are my thoughts on these.
The LLC for a start-up is fine, but they are not my preference. I actually prefer the S Corporations. They both have limited liability. They both can take investment capital, though the S Corporation restricts the type of investor and the number of investors. And they both allow “income to flow through” to the investors.
But S Corporations will not drain cash as quickly as an LLC. Investors in an LLC will be required to pay self employment taxes on the profits. If there are five investors, and three are not working in the business (true investors) and all split $500,000 profit equally in an LLC, the non-working investors will pay self employment taxes of about $12,000 each if they have no other earned income. In an S Corporation, they will pay nothing.
Other things to consider are costs. For example, the annual fee for the LLC starts at $500. For the S Corporation, it starts at $25. (In New York State; in New Jersey, the reverse is true) Further, lawyers seem to charge twice as much to form an LLC as they do a Corporation.
One final consideration: a one person LLC is filed as a Schedule C on Form 1040. A $100,000 profit would make the tax return look like a large taxpayer and possibly subject it to an Internal Revenue Audit. A one person Subchapter S corporation files Form 1120S and looks like a small business. It would be less likely to be audited based upon the identical numbers.
So in my opinion, the S Corporation for the start up makes more sense. Why pay more, or risk more, to get the same thing?