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The Pros and Cons of Forming Your Business as an LLC or S-Corp in New York

Every business is different, and whether you have are in the process of forming a new business or growing a business for years, it might be important to learn more about the pros and cons of LLCs and S-Corps.

March 20, 2019

Home » Blog » The Pros and Cons of Forming Your Business as an LLC or S-Corp in New York

Whether you are still in the process of formulating your business brainchild or have been successfully growing your NYC-based business for years, you should consider what type of legal business entity best serves the short- and long-term financial needs and goals of that business. Two of the most common entity types for both up-and-coming and long-established businesses in NYC are LLCs and S-Corporations (or “S-Corps” as they are commonly called).

Make no mistake, you are free to operate your business – whether solo or with others – without going through the steps to formally create an LLC or S-Corp, which in many cases would cause state, local, and federal authorities to view you as a sole proprietorship (if operating alone as a business owner) or general partnership (if you co-own the business). But doing so may not result in the most favorable tax treatment, and, even worse, may lead to unlimited personal liability, meaning not only would your business be at risk of going bankrupt over a careless mistake, but you yourself might be at risk as well.

Both LLCs and S-Corps offer the benefit of “limited liability” meaning that, in most (but not all) cases, only the business itself would face liability from third parties for matters like breach of contract, malpractice, or personal injury lawsuits. The business owners would not be personally liable outside of what assets were invested in the business.

Before you form either an LLC or S-corp, there are key differences you will want to understand with regard to formalities, operating arrangements, taxation and other issues.

The Cons of an LLC

Unlike S-Corp owners, members of an LLC must pay all applicable self-employment taxes on distributions, meaning Social Security and Medicare taxes will apply. Additionally, if the LLC is doing business in NYC, the NYC Unincorporated Business Tax could apply to distributions as well. While business losses can be factored into the members’ individual taxation situations, use of such losses may be limited depending upon the member’s level of participation in the LLC.

In New York, LLC members may not be put on the payroll of the company, meaning the members will be dependent upon distributions. New York also requires LLCs to go complete specific business formalities to operate, including filing annual reports and paying fees to the state. Finally, LLCs may be required to have a limited life span; for example, Technical Termination rules may apply when there is a “sale or exchange” of 50% or more of the total interest in “capital and profits” within a 12-month period.

The Benefits of an S-Corp

Again, as with an LLC, a primary upside to forming an S-Corp over a sole proprietorship or general partnership is the limited liability its owners will enjoy, a benefit that cannot be overstated. Note, however, that this protection will only be meaningful if the owners have not pledged assets to the S-Corp or personally guaranteed the corporation’s debt.

The profits of S-Corps are not taxed at the corporate level by either the federal government or New York State, and instead pass-through to the owners who will claim them on their individual tax returns (note that LLCs may opt for this tax treatment as well). That said, NYC may locally levy corporate taxes on S-Corp profits. Additionally, losses from the S-Corp may be claimed without limit by all shareholders (S-Corp owners are referred to as “shareholders” rather than “members”). And, unlike with LLCs, the distributions of S-Corp profits will not be subject to Medicare and Social Security taxes.

Shareholders of S-Corps can also be added to the company payroll, and must be paid a reasonable compensation. In another key difference from LLCs, S-Corps have an indefinite life span and may continue even if shareholders sell their stakes to new shareholders.

The Cons of an S-Corp

For all the benefits of S-Corps, their owners have less flexibility and favorable treatment than LLC members in a few key areas. S-Corps in New York may not have more than 100 shareholders, and those shareholders may only be U.S. individual citizens, trusts, or estates, meaning partnerships, corporations, or non-resident alien cannot be S-Corp shareholders (also note that not all states allow for the formation of S-Corps).

Unlike LLCs, S-Corps cannot distribute profits and losses disproportionately to their shareholders’ ownership stakes, meaning a 25% owner can only receive 25% of profits (or losses) without flexibility. It should be noted that, with regard to losses, a shareholder’s basis in the corporation does not include any of the corporation’s debt, even if the shareholder personally guaranteed it, which limits the amounts of losses that be passed through to a shareholder.

Similarly, S-Corps may have only class of stock, meaning shareholders will have the same rights and obligations as one another. Not only that, while shareholders can be employees of the company, shareholder-employees with more than 2% ownership interest are not entitled to many tax-favored fringe benefits available to employees or regular corporations.

Finally, because an S-Corp is indeed a corporation, there are corporate formalities that will apply to the S-Corp. This can include filing corporate paperwork with the state, having formal procedures in place for board meetings and meeting minutes, and creating additional corporate bylaws.

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Speak To a Business Formation Attorney For Guidance on Your Particular Business

Every business is different, and while the above is meant to provide broad outlines of the differences in regulations and treatments for LLCs and S-Corps in New York, a corporate formation attorney can provide particularized guidance to your situation. Contact a corporate formation attorney at The Fried Firm to determine the best course of action for your business.