1. When there are many passive members/shareholders.
An LLC treats the members as if they are self-employed, which results in the IRS
subjecting those members to the self-employment tax (15.3%) for social security (12.4%)
and medicare (2.9%). All of the LLC’s earnings are subject to the self-employment tax
regardless of whether a member actually works as an employee in the LLC.
In an S corporation, only the employment compensation paid to the shareholders
working in the business is subject to the self-employment tax. None of the distributions
paid or attributed to the shareholders are subject to the tax. With a 15.3% rate, the savings
can be substantial for those who are not working in the business. Also, only the wage
portion of an employee/shareholder’s business income is subject to the tax.
2. When the business wants to be able to issue stock.
Offering stock is a common way to raise capital, and is often a more attractive
investment opportunity than buying an interest in an LLC. While S corps have
restrictions on stock offering (only one class, no more than 100 shareholders, and
shareholder limitations), the shares are generally more freely transferable than interests in
3. When owners intend to seek venture capital and/or potentially go public.
Converting from an S corporation to a C corporation is much easier than
converting from an LLC to a C corporation. Most venture capital firms will choose to
invest in a C corporation, and while it is possible to have a publicly owned LLC, it is
seldom if ever seen. As such, if the owners plan to raise venture capital or take the
company public, it is generally preferable to do so as a C corporation. In order to more
easily transition to a C corporation when the time comes, the business should be
organized as an S corporation.
4. When the company wants to set up key employee stock option plans.
Success in growing a business often depends on retaining loyal employees. In
order to do this, many companies set up incentive stock options for key employees.
Employee stock option plans can be set up for both an LLC and an S corporation, but it is
much easier to do so in an S corporation.
If you are starting a business or are in business and are uncertain whether you selected the
ideal entity for your situation, give Brady Law Firm a call so that we can help you make
the right choice for your business.
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