Navigating Entity Structure for S-Corporations and LLCs: Key Tradeoffs to Consider

As many startups embark on their entrepreneurial journey, one critical decision involves choosing the business structure that best fits their unique needs. Two popular choices are the Limited Liability Company (LLC) and S Corporation (S Corp), each having its own nuances and specific governance structures.

Both S Corporations and LLCs offer "pass-through" taxation, where profits are taxed at the owner level, not at the business level. However, S Corporations' shareholders can potentially avoid self-employment taxes on a portion of the company's profits, a benefit typically not available to LLC members. S Corporations are required to adhere to stricter corporate formalities, such as maintaining minutes of board and shareholder meetings, issuing stock, and having a board of directors. Conversely, LLCs offer more flexibility in management structure and fewer ongoing formalities.

The choice between an S Corporation and an LLC depends on the specific needs and circumstances of the business. Consideration of factors such as ownership restrictions, tax implications, and management formalities can guide entrepreneurs in making informed decisions. Management structure and formalities will largely depend on the nature of ownership within a company. This can include the number of owners, the distribution of ownership percentages, and the specific needs of that business.

Let’s delve into the tradeoffs in entity structure for the three hypothetical ownership groups:

1. A single owner with 100% ownership

A straightforward single-member LLC would likely fit best for this owner. This structure provides the owner with complete control and flexibility over the business operations while maintaining a limit on personal liability to protect assets outside the business.

2. Three partners, each with 33.3% ownership

This owner group might elect to use either an LLC or an S-Corp based on their specific goals. The management structure might involve all partners equally participating in the decision-making process or could be organized with a designated managing partner, or a management committee.

In either structure, the owners need to have a comprehensive member agreement (LLC) or shareholder agreement (S-Corporation) detailing each partner's roles, responsibilities, and rights. The agreement would also cover the process for decision-making, profit distribution in the case of the LLC, dispute resolution, and provisions for adding or removing partners. All partners would be jointly and severally liable for the partnership's obligations.

3. A company with 10 owners each holding between 1% and 15%

This company would normally be organized as an S-Corporation as ownership is broadly distributed. The management structure for such a company would generally involve a board of directors responsible for making decisions on behalf of the company. Directors could be shareholders, but this is not a requirement.

Formalities are more complex in an S-corporation without a controlling owner. Being clear about the rights and responsibilities of the shareholders and directors, and the process for making major decisions is key. Regular board meetings are required. This company would need to be careful with its financial reporting, as well as adhering to the rules in the governing documents.

Although most needs can be met with one of these common pass-through entities, the best legal structure and governing rules are unique to each company, and consulting with an attorney may be advisable.

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DISCLOSURE: Jarrod Musick is an officer of Destiny Capital and Entrepreneur Aligned, a DBA of Destiny Capital. This article is for informational purposes only and should not be relied upon as a basis for your investment, business, or personal financial decisions. We recommend consulting with your wealth advisor, CPA/tax advisor and/or attorney, as applicable to your situation, prior to implementing any new tax, legal, or investment strategy.

ABOUT JARROD

Jarrod was born into financial planning and solving financial problems. With his financial advisor father Steve telling stories about finance around the dinner table from an early age, the idea that everyone has a different financial situation was always there. After an early professional career spent in nonprofit and government, Jarrod came back to his roots helping people plan and invest in 2011. Since then, he has worked with individual clients, led internal teams and ultimately became partner and the CEO of Destiny Capital in 2017. With a passion for helping entrepreneurs change the world, Jarrod ultimately oversaw the creation of Entrepreneur Aligned in 2020. With both Destiny Capital and Entrepreneur Aligned, Jarrod leads teams that help people live lives of abundance where money is simply a tool to let everyone be a positive force for the world around them. When he isn’t working with the talented teams for EA and DC you can find him chasing his twins, wily trout or a podium spot at an OCR race.