New business owners often struggle to determine if forming an LLC or incorporating is the right option for them.
LLCs and S-Corps are commonly cited options, particularly for solopreneurs. But while they have some overlapping benefits (like pass through taxation), they have several notable differences.
What is an S-Corp?
An S-Corp is a standard corporation in terms of setup but has elected Subchapter S status for taxation purposes. This means that the business owner has chosen to pass the corporate income, losses, deductions, and credits through to shareholders for tax purposes, avoiding the corporate level double taxation.
How to Set Up an S-Corp
Setting up an S-Corp initially looks much like setting up a traditional corporation. In fact, that’s exactly what happens. The first step is to form a corporation.
To form a corporation in Delaware, you’ll need to select a registered agent. Forming an entity in Delaware requires a Delaware address, which is what your registered agent provides (along with other vital services). Learn more about registered agent services here.
The state offers business owners the ability to file their own paperwork (you can do that here), though the state website notes, "The Division works closely with the registered agents that provide incorporating services and we encourage the users of this webpage to contact one of the registered agents for additional information."
If you plan to file your paperwork yourself, you'll need your registered agents name and address to do this. Business owners physically located in the state of Delaware can technically be their own registered agent, though it is discouraged. Here's why you may not want to be your own registered agent.
If you're utilizing a registered agent service (like The Incorporators) to form your entity, you'll provide them with basic details of the business including director information, contact information, stock, and par value. When the filing is complete, you receive a stamped filed copy of your Certificate of Incorporation, also called the Articles of Incorporation (here's what you need to know about the Articles of Incorporation). This document is the official proof that your company exists; much like a birth certificate for your corporation.
The Incorporators can take care of the setup for you and all of our packages include your first year of registered agent services. Check out our straightforward and affordable packages here.
Filing for S-Corp Status with the IRS
After the corporation is formed and you receive your Articles of Incorporation, you may file Form 2553 with the IRS within 75 days of the date of incorporation.
S-Corps are typically only recognized at the federal level although some states require that paperwork be filed at the state level as well. Delaware is not one of those states so Delaware corporations that file for S-Corp status at the federal level are viewed as corporations at the state level.
The form itself is four pages long and requires corporate details including the name, address, and signature of each shareholder or former shareholder required to consent to the election.
If you have any questions about the form, it’s best to consult your accountant or attorney to ensure you’re completing it correctly.
How are S-Corps Taxed?
Shareholders of an S-Corp claim the corporate income, losses, deductions, and credits on their personal income taxes. Shareholders are considered employees of the business and are typically given a salary with the corporation deducting the payroll taxes.
Delaware minimum tax for corporations is $175, with a $50 fee for filing the annual report (required). This amount may vary if the corporation is using the Authorized Shares Method or Assumed Par Value Capital Method. Learn more about Delaware franchise tax rates here.
Advantages of an S-Corp
The benefits of S-Corps most cited are:
- Avoiding double taxation
- Reducing self-employment taxes
- Simple transfer of ownership
- Limiting liability of shareholders
- Able to use the cash method of accounting
Drawbacks of S-Corps
S-Corps have more requirements and restrictions than LLCs including a limit of 100 shareholders, US citizenship requirement, stock restrictions, and industry restrictions.
What is an LLC?
LLCs are often thought of as a hybrid entity, with some of the best features of sole proprietorships, corporations, and partnerships.
Like a corporation, an LLC is a separate legal entity distinct from its owners; thus removing the owners and managers from any personal liability for the company's debts or obligations. Like S-Corps, LLCs are taxed via pass through taxation.
LLC Setup Process
Setting up an LLC in Delaware is a fairly easy process and much of the information above regarding the utilization of registered agent services still applies. You are able to set up your LLC yourself and will need to provide your registered agent's name and address on your documents. Utilizing a registered agent service for formation is encouraged and expedites the process, as registered agents receive most documents digitally instead of via postal mail.
When the filing is complete, you receive a stamped filed copy of your Certificate of Formation, also called the Articles of Formation. This document is the official proof that your company exists.
The Incorporators can create your documents and form your LLC for you. Check out our LLC formation packages here.
How are LLCs Taxed?
LLCs are taxed via pass through taxation. Pass through taxation refers to the tax structure of Delaware LLCs, where the business itself pays no income taxes. The business pays taxes through the individuals who control the LLC. They are taxed on their personal tax returns.
LLC members typically take distributions from the LLC – meaning they transfer money from the business bank account to their personal account usually via a bank transfer or check. Distributions may take place as often as the members would like and do not have to be in the form of a salary.
Delaware LLCs do pay an annual franchise tax fee to the state of Delaware. This is a flat fee of $300 and is due annually on or before June 1st.
Advantages of LLCs
- No shareholder/member limit;
- No restrictions on classes of members;
- No general liability;
- Limited liability for members and managers. Limited liability of members and managers to third parties;
- Taxable as a partnership for federal tax purposes;
- Flexibility of management structure due to the fact that management is pursuant to the LLC agreement;
- A fixed annual state franchise tax without regard to size or number of members.
LLCs are typically ideal for individuals running their business solo. Companies with multiple members or managers may benefit from the oversight of a board of directors that a corporation (including an S-Corp) requires.
It's also worth considering whether your business is going to seek funding from investors or require the ability to allocate stock. Venture capital firms often require a C Corp (traditional corporation) in order to invest.
Lastly, LLC members typically pay self-employment taxes on the distributions they receive.
How to Decide which Entity Type is Right for Your Business
If you are unable to attain S-Corp status because of the restrictions, then an LLC may be the appropriate choice for you.
Questions to ask yourself as you decide which is right for your business:
- Do I need to allocate stock?
- Am I going to seek funding?
- Would my business benefit from having a board of directors?
- How would I like to be paid or receive income from the business?
The ideal way to decide which entity type is right for your business is to discuss it with your accountant or attorney. They are best equipped to be able to assess your business structure and income and determine which entity type will benefit you most.
If you're ready to start your S-Corp or LLC, The Incorporators would be happy to help! Begin by selecting one of our packages here.