Friday, April 24, 2009

How to choose between California S-Corp and LLC

So you decided that you would like to protect your personal assets from that new or existing business you operate. But now you cannot decide between a corporation (most likely an S Corporation for smaller businesses) or a limited liability company.

Of course, once you choose a form of entity your work is not finished, as strict formalities are required and compliance is crucial to preserve any protection the entity provides. But the following advantages and disadvantages should help you decide. As always, you may want to consult an attorney to decide which factors are more important for your particular situation.

S Corporation Advantages

Shareholders enjoy limited liability. Ownership interests are freely transferable (subject to S Corporation restrictions). Existence unaffected by the death of shareholders or transfer of shares. Centralized management. Pass through tax treatment (as opposed to double taxation of C Corporations) Losses are available on the shareholders' personal income tax returns and can offset other income (subject to the "at risk" and passive loss rules).

Disadvantages: Formalities are required for organization and operation, more so than LLC Qualification is required for doing business in other states. Regular reporting is required. Strict qualification rules must be met on a continuing basis, which among other things limit the number and types of shareholders. The distribution of property by an S corporation to its shareholders is generally a taxable event for income tax purposes. Transfers of shares may be subject so securities regulations.

Limited Liability Company Advantages

Members enjoy limited liability. More flexible than S Corporations No limitation on the number or types of members. Centralized management is available if an LLC is manager managed. Assuming LLC is taxed as a partnership, pass through taxation. Losses are available on the members' personal income tax returns and can offset other income (subject to the "at risk" and passive loss rules). Special allocations may be made for income tax purposes. Disproportionate distributions may be made to members.

Disadvantages: Formalities are required however they are less onerous than S Corporations Regular reporting is required. Termination results from the death, disability, or withdrawal of a member under the laws of some states. Interests are not freely transferable. Business profits are taxed as income to the individual members and, as a result, may be subject to self-employment tax as well as income tax. Transfer of interests may be subject to securities law regulation.