Is the S-Corp a Dying Breed?

So, you have a great idea and want to start a new business, or your business is becoming established and you know you need to protect yourself with a separate business entity. What next? While there are different types of business entities, usually the question is whether a corporation or a limited liability company (LLC) is the right choice for your underlying business and the right choice from an ownership perspective.

Corporations and LLCs can share many similarities, depending on how they are structured. For example, if a corporation elects S Corporation status, then it is treated by the IRS as a partnership, meaning that profits and losses are passed through the corporation and are reported on the tax returns of the respective shareholders. If the corporation does not make such an election, then the corporation is subject to two levels of taxation: the first on the corporate profits, and the second on distributions to shareholders. Most small businesses elect to be treated by the IRS as a small business corporation, so the discussion below assumes that this election has been properly made.

While there are other similarities (and differences) between S corporations and LLCs, the most striking difference is the flexibility of the LLC with respect to who may be an owner, and the ability to establish different rights for different shareholders (called members) of the LLC.

For starters, an S Corporation is limited to 100 shareholders. Also, shareholders of an S Corporation may only be individuals, estates or certain trusts (partnerships and corporations cannot be shareholders). And most importantly, especially for Florida, all shareholders of an S Corporation must either be U.S. citizens or legal residents of the U.S. An LLC, however, is not subject to these limitations.

Another limitation of an S Corporation is that it can only have one class of stock, meaning that each share of stock must create identical rights with respect to the shareholder's right to receive dividends and distribution. Because an LLC can have multiple classes of stock, one class of stock could be entitled to a greater percentage of profit distributions than the other class of stock. What this means is that certain members could own Class A stock (technically called membership interests) giving them more control over the operations of the company (and the right to set salaries etc.), while other members could own Class B stock, giving them a higher percentage of the dividends, which would be distributed out of net profits (as determined by Class A holders). Additionally, an investor partner could own 80% of an LLC, and the sweat-equity partner (the partner who will handling the day-to-day operations) could own 20% of the LLC. However, profits could be split equally. The profit distributions of an S corporation, however, would have to be split in the same proportion as the ownership.

While there may be other considerations best served by choosing a corporation business structure (such as plans to take a company public, or issuing employee shares in the future), more and more businesses are bypassing the corporation structure and are being established as limited liability companies.

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