Are you deciding between forming an LLC or an S Corporation? For those starting a business in New York, the struggle to decide is real. Unlike most states, New York obligates LLC owners to publish a notice of formation in newspapers, which carries cost that makes an LLC seem less appealing. For this reason, it’s important to consider the differences between the entities before making the final decision.
What do they have in common?
LLCs and S Corporations are popular business entity choices for start-ups. They share two crucial similarities: (1) pass through taxation, and (2) liability protection.
1. Pass-through taxation: both entities avoid the issue of double taxation, meaning that the owners do not get taxed twice for each dollar taken out from the company.
2. Liability protection: this protects the owners in the case of their business failing, meaning they’ll only lose as much as they invested into the company. It’s important to note that an LLC (limited liability company) does not provide any more protection than an S corporation.
How do they differ?
1. Publication Requirement: Owners of an LLC formed in New York must publish a notice, in 2 newspapers from the county, within 120 days of formation. These publication costs can range from $350 in Albany, to over $1300 in New York. S Corporations are not subjected to the publication rule, therefore making them less costly to form in New York.
2. Formality: Owners of an S Corporation must follow a number of corporate formalities, including holding meetings for the board of directors, annual meetings of shareholders, and keeping records of all corporate meetings and significant transactions. LLCs are given a lot more flexible management, and while these formalities add to the cost of an S Corp, it can also be seen as framework for managing a company.
3. Restriction on Equity Classes: LLC owners are free to give investors membership interest that resembles preferred stock in a corporation. S Corporations do not get this flexibility. One stockholder rule for an S Corporation is that the corporation only has one class of stock. This means the corporation may not issue stock with preferential economic benefits. Issuing anything that suggests similarities of a preferred stock could cause an S Corporation to lose its S status.
4. Foreign Ownership and Investment: Whereas LLCs can have non-resident alien owners, an S Corporation does not allow ownership by a non-resident alien. This means a non-resident alien cannot become shareholder of an S Corporation. However, this does not mean a foreigner can never own an S corporation. Non-citizens who are lawful permanent residents (green-card holders) can own an S corporation.
5. Self-Employment/Payroll Tax: Owners of LLCs are not treated as employees of their company. For earnings drawn out from the LLC, they must pay self-employment taxes on their personal tax returns. In contrast, owners of S Corporations pay payroll taxes, if they work for the corporation, and have some leeway in adjusting the ratio of salary and dividends they receive in order to reduce employment taxes. LLCs can file Form 8832 and Form 2553 with the IRS to elect to pay taxes like an S Corporation, thereby having the S Corporation’s advantage in terms of employment tax.
|Formation Cost||Relatively high due to requirement of publication||Relatively low because no requirement of publication|
|Formality||Flexible management and less paperwork||Corporate formalities required and more paperwork|
|Restriction on Equity Classes||No||Yes|
|Foreign Ownership and Investment||Allows non-resident alien owners||Does not allow non-resident alien owners|
Question 1: Can I form an LLC in another state to avoid publication?
Not advisable. Formed in New York or not, if an LLC intending to do business in New York must meet the state’s publication requirement.
Question 2: Do I entertain appeal to venture capitalists by having an S Corporation over an LLC?
Maybe. While it is true that Venture Capitalists Hate LLCs, they do not like S Corporations any better because of the strict requirements. An S Corporation can convert into a corporation by revoking its S status, which is preferred by venture capitalists. An LLC can not undergo this change.
Fisher Stone Law- Business, Corporate & Startup Firm 25 Broadway Fl 9 New York, NY 10004 (212) 256-1877 www.FisherStoneLaw.com