When launching a new business, obviously you’ll spend quality time researching and analyzing marketplace dynamics, sources of working capital, buyer personas, competitors, products, services, locations – and the list goes on. All of these are vital pieces of the puzzle that will ensure that your business survives now, and thrives in the future.
However, there’s another critical decision that you need to make that might not be on your radar screen at the moment, but certainly should be since it will directly impact your potential tax liabilities and certain legal protection as well: whether you should incorporate as an LLC or an S-Corp.
LLC and S-Corp Similarities
First, let’s look at the similarities between these corporate entities. Both offer important advantages over operating as a sole proprietor, including:
- Directors, officers, shareholders and employees are all protected by limited liability provisions.
- Business owners can report their share of profit or loss on individual tax returns.
- Income isn’t taxed twice — unlike corporate income, which is taxed at the corporate level and then again at the individual level (as dividend income).
- The business can sell shares of stock or membership interests in order to generate investments.
- The businesses continues to exist even if the owner exits or passes away.
LLC and S-Corp Differences
The biggest and most important difference between an LLC and S-Corp is how these entities are taxed. An LLC may follow either the partnership tax code or the corporation tax code, or it can even be taxed as a separate entity altogether (i.e. not connected tax-wise to the business owner). An S-Corp, however, always follows the corporation tax code.
Which Option is Better?
As you can expect, it’s beyond the scope of this (or any other) article to definitively advise you on which entity is right for your business. Ultimately, you’ll need to seek help from a tax attorney who will help you analyze several factors, including:
- The type of business that you’re conducting.
- How you, any other business owners, and investors will be compensated or paid back.
- Your optimal exit strategy.
The Bottom Line
Remember that your initial choice of business entity cannot (in most cases) be changed in the future without incurring significant additional tax liabilities, as well as other administrative and filing fees. As such, make sure that you work with a tax attorney before you incorporate — not after — to get the objective, accurate and reliable information you need to make a smart choice of entry decision that will make sense for both the short term and the long run.