If you plan to start a company in the real estate industry, do you form a Limited Liability Company (LLC) or an S-Corporation? Since protecting personal assets is an important factor for establishing a company, many real estate investors decide to organize their companies as an S-Corporation or an LLC.
Differences Between an LLC and an S-Corporation
Although both types of businesses share many similarities that include the protection of personal assets, some differences can help you decide on which type of business to form.
Tax Status vs. Type of Business Entity
An S-Corporation is not a legal business entity, but is considered a tax status created by the Internal Revenue Service (IRS). Conversely, LLCs are a type of business entity created under state law. One of the unique things about an LLC is that the members can choose for the IRS to tax them as an S-Corporation.
Members vs. Shareholders
Like all corporations, an S-Corporation is comprised of shareholders that have a financial stake in the performance of a business. The IRS has issued restrictions on S-Corporations that include no more than 100 shareholders and each shareholder must provide proof of American citizenship. On the other hand, an unlimited number of members can own an LLC, with the members choosing whether to be active managers or simply members with no management responsibilities.
Formality vs. Informality
An S-Corporation must follow several formal guidelines for forming and running a business.
- Create and follow company bylaws
- Issue stock to each shareholder
- Schedule at least one meeting per year for shareholders
- Take minutes at each shareholder meeting
- Maintain accurate financial records
An LLC typically does not have to follow these formal guidelines. Nonetheless, the IRS encourages that the members of an LLC abide by an operating agreement, hold at least one meeting per year for members, and keep documents that describe every significant financial decision.
Benefits Both Types of Businesses Enjoy
Although there are differences between an LLC and an S-Corporation, the similarities deliver several benefits. Two benefits are particularly important for the members of an LLC and the shareholders of an S-Corporation.
Personal Asset Protection
Both an LLC and S-Corporation offer the members and shareholders protection against being personally liable for the debts of a business. The legal system considers the two forms of businesses to be separate legal entities from the members and the shareholders. This means creditors cannot touch the personal assets of the members of an LLC or the shareholders of an S-Corporation.
Standard corporations, which go by the name C-Corporations, have to pay taxes two times for the same income. The corporation pays an income tax on the profits generated by the company, while the shareholders are on the tax hook for the dividends they receive.
LLCs and S-Corporations enjoy the benefit of pass-through taxes. The business does not have to pay an income tax. Instead, profits “pass-through” to the members as personal income. The members file individual tax returns and the business does not file any income tax paperwork with the IRS.
What Should You Do?
The answer to this question is not clear-cut. Deciding whether to form an LLC or S-Corporation can be confusing, especially when you consider the role states play in the formation of businesses. The best answer is to meet with an experienced business attorney who has helped clients decide which of the two forms of businesses they should create.
Schedule a free consultation with an attorney from the Cloud Peak Law Group to determine whether you should form an LLC or S-Corporation for your real estate business.