LLC vs S-Corporation – Which Is Better for Asset Protection?
When it comes to personal finance, identifying the right form of asset protection follows a relatively standard process. There are options such as opening a traditional IRA, or ROTH IRA, putting your money into a certain trust, as well as gifting it to a relative to secure it from creditors. However, when it comes to business, protecting personal and business assets may become a little tricky. Typically, entrepreneurs are faced with the question of whether they should open a limited liability company (LLC) or an S-Corporation, among many other types of business structures. Both LLCs and S-Corporations are great methods of asset protection as they offer extensive and distinct asset coverage in the case that something goes awry in the course of business. Figuring out which structure can help save you more money can be a strenuous process and entrepreneurs need to weigh the pros and cons of both before they decide to use either for asset protection purposes.
What is an LLC?
A limited liability company, also known as a LLC, is a United States-specific form of a private company. It is a business structure that combines the pass-through taxation of a partnership or sole proprietorship with the limited liability aspect of a corporation.
What is an S-Corporation?
An S corporation is a closely held corporation that makes a valid election to be taxed under Subchapter S of Chapter 1 of the Internal Revenue Code. It is a special feature of business ownership within the United States that allows for a corporation to avoid double taxation because it is not required to pay corporate income taxes on the profits of the company. In an S-Corporation, all profits and losses are directly passed on to the shareholders of the company.
What are the pros of an LLC?
You may be familiar with the acronym LLC; you’ve seen it at the very bottom of websites, and sometimes even in contracts. An LLC provides liability protection for members and managers; it protects the owner’s assets from facing personal lawsuits from clients or customers with whom he’s done business. In addition, LLCs generally require less paperwork and lower filing costs. In an LLC, all external business-related lawsuits will be held against the company rather than the individual owner. LLCs are also easier to maintain since they allow easier maneuver of income to business members while avoiding unnecessary taxes. For example, if you were to start a record label and sign an artist, for every gig the artist books, you would receive $1,000.00. In a turn of events, the artists claims that you have been getting paid $1,500.00 instead and wants to file legal action. An LLC would protect all income made from that time period and all assets you have outside of the contract. Also, at any point an LLC may choose to be taxed as an S-Corp or a C-Corp (another type of company) by filing a document called an election with the IRS.
What are the cons of an LLC?
Some cons of an LLC are that the renewal fees or publication requirements can be pricey, and even if you are a member of your own company, you cannot pay yourself any wages. Other cons include LLCs being subject to franchise and capital values taxes in select states, as well as ownership of the LLC needing to be distributed among all company members (which can also be a pro).
In keeping with the record label example, you would not be able to pay yourself as a manager. The $1,000.00 you make is the artists’ payment to you, however you would not be able to claim any other money from her. All of your income comes from your employees.
What are the pros of an S-Corporation?
As with LLCs, owners of S-Corporations are protected from legal liability. An S-Corporation also has the ability to sell stock as well as the option to purchase stock at a fixed price. Additionally, opening an S-Corp allows the owner(s) of the business to write off any eligible start-up losses from their chargeable taxes.
What are the cons of an S-Corporation?
While owning an S-Corporation does allow for numerous benefits including pass-through taxation, this type of company is not without its downsides. For one, S-Corporations are highly scrutinized by the IRS since tax policy changes with the way payments are distributed to employees (salaries or dividends). Additionally, ownership of an S-Corporation is capped at 100 shareholders, and owners run the risk of losing S-Corp status if the IRS learns that there is a greater number of people running the company.
LLC’s vs. S-Corporation in Court
In the case of Naples vs. Keystone Building and Development Corp, a family entered into a contract with Keystone to have a new home built for $600,000, and discovered major problems with the property shortly after moving in. While Keystone did send multiple crews to make repairs, the problems persisted. The Naples filed a lawsuit asking for over $100,000.00 in repairs, but being that Keystone was an LLC, their assets remained protected and the court only awarded the Naples family a total of $57,000, half of the alleged damages, after the trial. With regard to this case, an LLC and an S-Corporation would have served the same legal purpose as both offer limited liability protection.
Is An S-Corporation An LLC?
It is important to note that, in the eyes of the IRS, the terms LLC and S-Corporation essentially refer to the way in which a company is taxed. A multi-owner LLC is taxed like a business partnership by default, though LLCs can choose to be taxed as S-Corps after filing an election. Though an LLC can technically choose to be taxed as an S-Corp, the two business structures are inherently incongruent. One such incongruence is that LLCs are known to be less expensive and require less paperwork while S-Corps tend to be more tricky to legally form.
Can An S-Corp Be A Member in An LLC?
This is where it gets interesting. An S-Corp may own up to 100% of an LLC, however, LLCs are not permitted to have any ownership stake in S-Corporations. Single owner LLCs, called “disregarded entities” by the IRS, are the only known exception regarding the ownership of S-Corp stock by LLCs and are allowed to own and receive profits from S-Corps in which they hold a position.
What type of company should I open?
As mentioned earlier, LLC’s and S-Corporations are great tools for asset protection. They both provide protection for your personal assets and come with multiple tax advantages. Before settling on one option for your business, make sure to consult with a licensed asset protection attorney who can help guide you along the path of deciding which type of company will benefit you in the long run.