“I’m trying to decide between an LLC and an S-Corp.” said a riding instructor I talked to recently. She’s making the transition from freelancing to having her own school, and the mother of a student had emphasized the importance of “having the right structure”. Until she could figure out what was ‘right’, her plans were on hold.
Unfortunately, she had fallen victim to a very common confusion. LLC is a legal structure. S-Corp is a tax structure. It’s like asking if you want a Quarter Horse or a mare.
We’ll look at legal structures first, and consider tax structures in Part 2.
Legal Structures For business
Sole Proprietor is the oldest and simplest form of business structure. It’s one person, in business for him- or herself. In a sole proprietorship, the owner is the business and the business is the owner. There is no distinction.
Pros: It’s quick, cheap, and easy to start, just hang out your shingle or hand out your cards.
Cons: No distinction between business and personal means that if you get sued, everything you own is at risk.
Partnership is also an ancient business form. It’s two or more people, in business together.
Pros: Quick, cheap, and easy to start—say you’re in business together and you are.
Cons: Each partner is fully liable for the debts & judgements of the partnership, so you could be stuck paying for the damage your partners caused, even if they acted against your instructions.
Corporation: This modern business structure is legally its own “person”, separate and distinct from its owner(s).
Pros: Owners’ liability for acts of the business is limited to losing what they have invested in the corporation. Shares of stock (ownership) can be sold to a large number of different people, making this the best structure for growing a big business.
Cons: Takes time, money, and (usually) a lawyer to form a corporation. Most state governments charge annual fees to remain in legal existence. If corporate business is not kept separate from the owners’ personal activities, protection from liability can be voided by a judge.
Limited Liability Company (LLC): In the United States, LLC’s are the newest and most popular legal structure for small businesses.
Pros: LLC’s provide the protection of a corporation, without most of the expensive formalities. They are the only legal structure that offers a choice of tax structure (to be discussed in Part 2).
Cons: Rules for LLC’s vary more between states than for other structures, which makes good organizing documents especially important. Terminology can be confusing—for example, owners of an LLC are called “members”. Most state governments charge annual fees to remain in legal existence. If corporate business is not kept separate from the owners’ personal activities, protection from liability can be voided by a judge.
There is no “right” legal structure—just the best choice for any particular business, at a particular stage of its lifecycle.