Should Your Startup Be an S-Corp or an LLC?

If you are an entrepreneur who wants to start up a small business in New York, one of your first considerations will be the choice of business entities.  If you work on your own, and decide to set up a sole proprietorship, this article is not for you.  For non-professionals (licensed by the State of New York) who don’t want a sole proprietorship or traditional partnership, your practical choices are the limited liability company (LLC) and the S corporation.

The primary purpose of a business entity is to protect an individual or group of individuals from liability for the actions on behalf of that business.  As an individual, you don’t want people to whom your business owes money to come after you.  S-Corps and LLC are “pass through” entities, in other words, income from the business is treated as income of the individuals who are owners in the business.

• Upstart vs. Traditional: LLCs are a lot more flexible—you can write the structural rules of the LLC. S-corps, on the other hand, are required to maintain corporate formalities in order to keep their liability protection. S-corps have a bunch of requirements that you associate with a traditional corporation: minutes, board of directors and officers, and specific accounting and record-keeping procedures.
• Distribution of Money: Obviously if it's just one person, the issue of monetary disbursement is less complicated.  The fact is, if you have an uncomplicated structure and you know that you will have an uncomplicated structure in which distribution of income is 50/50 or 33/33/33, you may have no need for flexibility.  An S Corp may be for you.  However, you and your fellow co-venturers may want to structure the business in a way that rewards different people (or even entities--allowable in an LLC, not allowable in an S Corp) for the amount of money or number of resources are procured for the business.  For instance, let's say one owner puts up most of the startup costs and gets 90% of the investment capital, while the other owner only gets 10% of investment capital and does 90% of the work.  You might want to create a 75/25 split for the owners in the first year, and then be 60/40 in the second year, etc.  You can do that in an LLC.  You can't do that in an S-Corp.
• Shareholders vs. Members: In NY, an LLC may be owned by an entity, not just an individual.  Owners in an LLC are called members.  LLCs can also have managers. Owners in an S-Corp are called shareholders.  They are people, and no more than 100 people.
• The Future of the Business: If you plan to one day move the business overseas, where LLCs are often not recognized, or if you plan to become a C-Corporation, an LLC may not be the right entity.  If in the future, you want to have different forms of distribution of income, or have entities as owners, you may prefer LLCs.  Be sure to discuss all of your concerns and questions with a knowledgable attorney AND tax advisor.
• Taxation: Lawyers love LLCs because of their flexibility, but you may find taxation to be favorable with an S Corp.  You should discuss tax issues with a CPA and/or tax attorney.  Nonetheless, the IRS and theNew York State Corporation websites have thorough explanations of tax differences between S Corporation and LLCs.  This is what the New York State Taxation website states:

  Tax treatment of LLCs and LLPs

  Initial Actual Cost to You: LLCs have publishing requirements in New York State, and ethically, you are to publish announcements in the county in which you primarily do business.  Publishing in New York County (Manhattan), for instance can cost thousands of dollars.  Rockland is substantially cheaper. The formalities involved with S-Corps may make the initial costs higher than that of an LLC.
  • The New York personal income tax and the corporate franchise tax conform to the federal income tax classification of LLCs and LLPs. 
    
    
    • An LLC or LLP that is treated as a partnership for federal income tax purposes will be treated as a partnership for New York tax purposes.
    • An LLC or LLP that is treated as a corporation, including an S corporation, for federal income tax purposes will be treated as a corporation for New York tax purposes or as a New York S corporation if the New York S election is made.
      
      
  • A single-member LLC (SMLLC) may choose to be taxed as a corporation, including an S corporation, or to be disregarded as an entity for federal income tax purposes. 
    
    
    • If the LLC is disregarded and the single member is an individual, the LLC will be treated as a sole proprietorship for New York tax purposes. 
    • If the LLC is disregarded and the single member is a corporation, including an S corporation, the LLC will be considered part of the corporation for New York tax purposes.
      
      
  • For information regarding the tax treatment of an LLC or LLP for purposes of the New York City General Corporation Tax (GCT) and the New York City Unincorporated Business Tax (UBT) is provided in the New York City Department of Finance Memorandum 99-1.

  Tax responsibilities

  • An LLC that is treated as a sole proprietorship must report its business income and expenses on the individual's New York State personal income tax returns.
  • An LLC or LLP that is treated as a partnership may be required to file a Form IT-204, Partnership Return.
  • An LLC or LLP that is treated as a C corporation for federal income tax purposes or that has elected both federal and New York State S corporation status must file a New York State corporation franchise tax return.
  • An LLC or LLP may be required to pay a filing fee and/or estimated income tax on behalf of certain partners or members.

  Paying tax as a shareholder of a New York S corporation

  • Shareholders pay New York tax on their pro rata share of the S corporation pass-through items of income, gain, loss, and deduction that are includable in their federal adjusted gross income.

  • Nonresident shareholders pay tax only on the S corporation items derived from New York sources, which is determined at the corporate level.

  Paying tax as a New York S corporation

  • Under the corporation franchise tax (Article 9-A), you pay a fixed dollar minimum tax based on New York receipts.
  • A license fee or maintenance fee may also apply if you're a corporation formed outside of New York.
  • The metropolitan transportation business tax (MTA surcharge) doesn't apply to a New York S corporation.
  • The only credit that a New York S corporation may apply against the S corporation's franchise tax is the special additional mortgage recording tax. However, the S corporation may earn other tax credits that flow-through to the S corporation shareholders to be claimed on the shareholders' individual returns. 
  • Under the corporation franchise tax on banking corporations (Article 32), you pay the higher of:
    • the tax on entire net income, computed as if the S corporation had not made the federal S corporation election, reduced by the Article 22 tax equivalent; or
    • the fixed dollar minimum tax of $250. (Generally, the fixed dollar minimum tax is the higher amount.)