The number one question I get when planning a new business is whether to create an LLC or an S-Corp. Choosing between these two types of entities can be difficult for business owners who are not familiar with the unique features of each type. To choose the right one for your business, you should be aware of their similarities and differences.
LLCs and S-Corps are entities legally allowed to organize as a business under Texas law. Both legal structures provide limited liability – a “corporate veil” that means owners are not personally responsible for the business’s liabilities or debts, although there are some exceptions.
The goal of each entity is to protect business owners’ personal assets from being reached in lawsuits against the business or by the business’s creditors.
The LLC is a newer entity structure that generally provides more flexibility than the S-Corp.
In Texas (and most states), the law requires the name of an LLC end with the words “Limited,” “Limited Liability Company,” or an abbreviated form of those terms.
In contrast, the name of a corporation must end with “Incorporated” or “Corporation”.
This distinction is important because your application may be rejected if you fail to comply with these naming requirements.
The owner of an LLC is typically called a member, and ownership interests can be defined by units (similar to shares of corporate stock) or by percentage.
On the other hand, the owner of a S-Corp is called a shareholder or stockholder, and the units of ownership are called shares or stocks. The structure of the S-Corp transfers easily by dividing ownership into these units.
LLCs with ownership interests consisting of units borrow this structure from the S-Corp, reflecting the LLC’s flexible nature.
LLCs typically take one of two basic structures: member-managed or manager-managed.
In member-managed LLCs, the members conduct the day-to-day management of the LLC.
In manager-managed LLCs, one or more managers make decisions for the entity. An LLC’s operating agreement may even require that managers of the LLC be members.
In S-Corps, by default, a board of directors has management authority. The board is answerable to the shareholders and is charged with the day-to-day management functions.
The members of an LLC also have the flexibility to choose to create a board of managers like an S-Corp’s board of directors.
LLCs, unless they choose to be taxed differently, enjoy pass-through taxation. This means that the LLC entity itself is not taxed; rather, the taxes flow through to the LLC’s members.
On the other hand, some corporations are subject to double taxation. This means some corporations must pay taxes on corporate income, and the corporation’s shareholders must also pay taxes on the dividends they receive.