If you are starting a business in New York, you might be wondering whether to opt for a limited liability company (LLC) or an S-corporation (S-corp) entity structure. Both offer limited liability protection, but there are significant differences between the two that can affect your business in New York.
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Overview of LLC and S-corp
An LLC is a flexible and easy-to-form entity structure that combines the benefits of a corporation and partnership. It offers the members (owners) limited liability protection and pass-through taxation. In other words, an LLC's profits and losses "pass through" to the members' individual tax returns.
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An S-corp is a type of corporation that allows the shareholders (owners) to enjoy limited liability protection while avoiding double taxation. Similar to an LLC, S-corp shareholders report their share of profits and losses on their individual tax returns.
Formation
To form an LLC in New York, you need to file articles of organization with the New York Department of State. You should also create an operating agreement that outlines the company's management structure, debts, and obligations, among other things. The operating agreement is not mandatory, but it is highly recommended as it protects the LLC's limited liability status.
Forming an S-corp in New York involves filing articles of incorporation with the New York Department of State, and filing Form 2553 with the Internal Revenue Service (IRS) to elect S-corporation status. You should also adopt bylaws that outline the corporation's management and shareholder rights and responsibilities.
In either case, it is crucial to comply with all state and federal regulations when starting and operating your business.
Management
An LLC can be managed by its members or by managers appointed by the members. Members have more flexibility in managing an LLC than shareholders in an S-corp.
In an S-corp, shareholders vote on major decisions such as electing directors, amending bylaws, and issuing stock. The directors, in turn, appoint officers to manage the daily operations of the corporation.
Capital Requirements
New York does not impose any minimum capitalization requirements to form an LLC or S-corp. However, an LLC can have different kinds of membership interests, such as capital contributions, sweat equity, or intellectual property. Therefore, it can be easier and more flexible to raise capital in an LLC than in an S-corp, where all shareholders must hold the same class of stock.
Taxation
As we mentioned earlier, both entities offer pass-through taxation. In an LLC, all profits and losses pass through to the members' individual tax returns, and they pay self-employment taxes on their share of the profits.
In contrast, an S-corp's profits and losses also pass through to shareholder's individual tax returns, but they are not subject to self-employment taxes. Instead, S-corp shareholders pay themselves a reasonable salary and receive the remainder of their profits as distributions. The salary is subject to income and payroll taxes, while the distributions are untaxed.
Although S-corp shareholders can save on self-employment taxes, they must maintain reasonable compensation based on their industry and their roles in the company. The IRS closely scrutinizes the compensation level to prevent abuse of the system.
Conclusion
Deciding whether to form an LLC or S-corp in New York involves weighing several factors such as management, capital requirements, taxation, liability protection, and regulatory compliance. If you prefer more flexibility in management, capitalization, and taxation, you might opt for an LLC. If you prioritize minimizing self-employment taxes and not subjecting your profits to double taxation, you might choose an S-corp.
Either way, it is best to consult a New York business attorney and accountant to help you navigate the state and federal laws and regulations and make an informed decision based on your unique business needs.
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