As a business owner, you have to choose the structure that your mobile pet grooming business will take. You can opt to register your grooming business as a sole proprietorship, LLC or an S-corp. Unfortunately, a sole proprietorship has unlimited liability; thus, it is not the best choice. So the question comes down to LLC or S-Corp? Since these two forms of business have some features in common, it becomes a challenge for business owners to choose. On the flip side, these two are also distinctly different.
In this article, we will compare LLC and S-corp.
What is an LLC?
An LLC (limited liability Company) is a business entity that is legally separate from its owner or owners referred to as members.
What is an S- corp.?
An S- corp. is not a business structure but an indicator of how a business chooses to be taxed under the state tax laws.
Similarities between LLC and S- corp
Both provide limited liability
An LLC or S-corp offers limited liability protection for business owners. As opposed to a sole proprietorship where the owner may lose his/her assets to business creditors, the LLC or S-corp will protect your assets from your business creditors. Both S corporations and limited liability companies exist as separate legal entities. Therefore, the business will settle its debts on its own without affecting your personal assets.
Both offer pass-through taxation
Both LLCs and corporations do not pay tax at the business level, but they are passed through to the individual level. This helps you to avoid being taxed twice- at the corporation level and individual level. However, it is important to note that although they are both pass-through entities, they are under clear federal tax laws.
Both are separate legal entities
LLCs and corporations are separate legal entities that are formed by filing papers with the state.
Both are under ongoing state laws compliance
Both structures have a legal obligation to comply with certain rules that apply to LLCs and corporations. Examples of such statutes include filing annual reports, paying annual fees and issuing notifications to the state in case of changes.
LLC vs. S corp
Despite the similarities, these two structures have differences that set them apart from each other. Below are the differences between an LLC and a corporation in terms of advantages.
Advantages of LLC over an S- corp
Flexibility in management
Most people prefer LLCs over corporations due to their flexibility in management. All corporations, (C corporations or S corporations) have to comply with many corporation laws on management. On the other hand, LLCs do not have strong laws regarding management. For example, corporations have mandatory requirements to hold annual meeting for shareholders and another for directors; to take record of meeting minutes and to give proper notices. LLCs are thus flexible as they do not have such rigid requirements.
Besides, owners or managers can manage LLCs. When members take on management, they enjoy the benefits of a partnership or a proprietorship in case of one owner. S- corps, on the other hand, can only be managed by a board of directors. Shareholders do not have a part in the management of the corporation.
No restriction of ownership
The Internal Revenue Service (IRS) does not restrict the ownership of limited liability companies, but it restricts that of S corporations. While LLCs can have an unlimited number of shareholders, an S-corp can only have members to a maximum of 100. LLCs can have non-US citizens as members, but S corporation members must be US residents.
In addition, the owners of an LLC can randomly allocate profits or losses among members whereas an S-corp must allocate profits or losses on the basis of ownership percentage.
LLCs can be owned by partnerships, corporations, partnerships, and many trusts but an S-corp cannot.
Advantages of an S-corp over an LLC
Ease of obtaining external funding
Most investors such as banks prefer to invest in a corporation as opposed to LLCs. As a result, corporations can easily obtain funding from the outside unlike LLCs. Besides, corporations have been around much longer than LLCs. For this reason, they are more established and familiar with attorneys and other relevant professionals.
Ease of conversion into a C corporation
An S corporation can easily change into C Corporation by filing an IRS form. However, it is more complicated for an LLC to change into a C corporation. To change to a corporation, the LLC will have to dissolve and incorporate or join a statutory conversion scheme or merge into a corporation.
Transfer of ownership
An S-corp shareholder can easily transfer his or her shares as long as the IRS requirements are met, but the ownership of an LLC member is not easily transferrable unless approved by another member.
Reduced self-employment taxes
The amount of self-employment taxes due by an S-corp depends on the amount of salary taken. The salary is a deductible business expense which the corporation can reduce by paying a fair amount of salary to its owners. The rest of the net income is treated as a distribution and not subject to taxation. An LLC on the other hand, cannot reduce its self-employment taxes.
Making your choice- which structure is right for your mobile pet business?
Clearly, both LLC and S-corp have their pros and cons.
There are situations under which you may prefer an LLC. These situations include but not limited to the following.
- If you prefer flexibility in the management of your business.
- If you want to use your own criteria to split profits and losses as opposed to the basis of ownership percentage.
- If you would wish to avoid the state-mandated meetings imposed on corporations.
- If you do not plan to sell your shares to raise capital.
- If you want to enjoy pass-through taxation.
On the contrary, you may prefer an S-corp if:
- You have future plans of becoming a C-corp.
- You prefer salary to self-employment income.
- You need to obtain investment capital with ease.
- You want profits and losses distributed according to ownership contributions.
- You prefer pass-through taxation.
Finally, there is no right fit when it comes to LLC or S- corp. The suitable structure will depend on your current business needs as well as your future plans. It is important to work with a business professional to guide you