Once you decide to start a business, you will also need to decide what type of entity to use for that business. In the past, small businesses typically elected to be Subchapter S corporations, which provided protection from personal liability for the “owners” (i.e. the shareholders), while also avoiding income tax liability at the entity level. Due to changes in IRS treatment over the last few years, many small business owners now elect to form limited liability companies instead of corporations. What is a limited liability company and why have they become so popular?
A limited liability company is a business entity that functions like a hybrid between a corporation and a partnership, enjoying the “best of both worlds”. Similar to a Subchapter S corporation, a limited liability company (or LLC) provides protection from liability for its owners (i.e. the members), and can be taxed like a partnership which also allows avoidance of tax at the entity level. An LLC, however, does not have the same restrictions and limitations as a Subchapter S corporation. For example, there are no limits on the number of members that a limited liability company may have and there is no requirement that all members be individuals. Additionally, unlike a corporation, an LLC may be structured in any manner that the members desire, including with regard to control and management; payment of distributions; and allocation of losses. With a corporation, distributions and allocations must be based solely on stock ownership.
In order to form a limited liability company, articles of organization must be filed with the Department of State. The current filing fee in Florida is $125, slightly more than the filing fee for a corporation (i.e. $75). The members then need to enter into an operating agreement, which functions like a shareholders agreement and partnership agreement. This document sets forth the terms and conditions for the operation and management of the company, as well as any restrictions on the transfer of membership interests, admission of new members, etc. Due to the allowable flexibility, the operating agreement typically is a more complicated document than the bylaws for a corporation and may lead to a slightly higher cost of organization.
The decision whether to use a Subchapter S corporation or LLC depends on each particular situation. The first thing you should do before you decide to start a business is to speak to your accountant or tax advisor to determine which type entity suits your tax needs best. There are differing tax treatments between the two types of entity and your tax advisors will be best suited to guide you to an informed decision.
Rick welcomes your questions about this article at RKBARRA@SCOTT-HARRIS.COM