Choosing Between Limited Liability Company and Subchapter S Corporation

Written by Marty Bodnar

People often contact PSED to start a business after a career in corporate America. Usually, these people just want to keep it simple and want an entity that will have limited liability, meaning that creditors can’t go after their personal assets but can only go after the assets of the new entity.

The two types of legal entity that offer simplicity along with limited liability are Limited Liability Companies (“LLC”) and Subchapter S Corporations (“S Corp”). 

Both entities are created under the laws of the State of Michigan. Articles of Organization are filed to create an LLC; the end of its name must use “LLC.” Articles of Incorporation are filed to create a Corporation; the end of its name must use “Inc.” or “Corp.” Please note that a Michigan Corporation becomes an S Corp when it files an election for tax status with the IRS.

Owners of an LLC are called “members” whereas owners of S Corp are called “shareholders.” Members can choose to manage the LLC themselves. On the other hand, shareholders must elect a board of directors, who then choose the officers to manage the S Corp. The shareholders can elect themselves to the board and then choose to become the officers of the S Corp.

Both LLC and S Corp provide simplicity in taxation. Federal tax law allows the income of these entities to pass through directly to the owners. However, this pass-through tax treatment is obtained differently depending on which form you choose. 

With an LLC, such tax treatment is automatic. There are no forms to file and no eligibility criteria to meet. An S Corp must file IRS Form 2553 to obtain such tax treatment and must meet certain criteria including not having more than 100 shareholders or nor more than one class of stock.

Despite both forms having this favorable pass-through tax treatment, the treatment of self-employment tax is an important difference. This tax is an additional tax on the income of the self-employed. Shareholders of an S corporation are generally not subject to this tax whereas members of an LLC must pay it.

Under Michigan law, the case law on LLC is scant, whereas it is more developed for Corporations. Until case law concerning LLC is more fully developed, there will be some uncertainty about the treatment of LLC in court.

If you’re interested in learning more about business law or whether LLC or S Corp is best for your new business, please call Marty Bodnar at 734-665-4441 or email him at mbodnar@psedlaw.com.