A Limited Liability Company, or LLC, is a business structure established to separate the individual owners of that company from being personally liable for the actions of the company. An imaginary wall goes up, and if the LLC finds itself in financial jeopardy, the personal assets of the members are not exposed. An LLC also serves as a taxation structure for its members. Individual states set their own regulations regarding LLCs.
In a stock-based corporation, stockholders own a certain percentage of the company, but control of the company rests with the management. In an effort to raise funds while still maintaining the pass-through tax benefits of an LLC, the LLC may elect to become an S-corporation, through which shares of stock can be issued.
Starting an LLC
An individual has an idea for a business, and several of his friends have agreed to join him in launching it. The simple way to structure the business is by forming a Limited Liability Company. The state regulates LLC guidelines and issues the paperwork. An Operating Agreement, whether he is going into business alone or with partners, must be filed. He pays the fee, and now he’s in business.
The tenets of LLC membership state that all members have equal rights regardless of their membership investment; however, their percentage of ownership is based upon their investment. Also, a financial investment isn’t necessary to become a member. Contributions, such as a specific expertise, known as “sweat equity,” also qualify.
As a partner in an LLC, an individual is recognized as having an ownership interest. However, in an S-corp, she is now an employee as well as a shareholder, so her tax liability differs. There are still the pass-through benefits of the LLC, but it’s calculated differently.
Becoming an S-Corporation
While membership conditions, paperwork and a working structure for forming an LLC are less complicated than that for an S-corp, an individual may wish to “elect” to change the LLC’s status. He has approximately 75 days from the date of the LLC’s initial filing to change the organization’s classification. Additionally, all members of the LLC must present a written agreement as to the change in status.
A single member LLC cannot elect to become an S-corp, and limitations exist as to the profiles of the newly structured company and its partners.
- The company must be registered in the United States.
- No foreign entities or companies can be shareholders.
- All shareholders must be U.S. citizens or permanent residents.
- The IRS allows only 100 shareholders.
In addition, extensive paperwork is involved when electing to become an S-corp. Establishing bylaws, deciding on the amount of stock to be issued, holding annual meetings and recording them – these are just a few of the changes when converting the structure of the business.
Read More: Can an S Corporation Be a Member of an LLC?
Issuing S-Corp Stock
While the total amount of stock that can be issued must be stated in the S-corp’s Articles of Incorporation, the number of individual shareholders is limited to 100. Some estates and trusts are eligible to purchase stock as well, and married couples are considered one investor.
When issuing stock, most S-corps hold back shares to be made available in the future when additional funding is needed. This avoids the need to amend the corporation’s articles to increase the number of shares it offers.
An additional strategy involving stock is to authorize a stock split. However, the total amount of shares cannot be more than that stated in the initial Articles of Incorporation.
Losing S-Corp Status
Any violation of the Articles will result in the S-corp’s losing its status, resulting in the entity becoming subject to double taxation, which is the main reason for forming it in the first place.
Unlike a corporation issuing stock, when an S-corp holds a stock offering, there cannot be preferred shareholders or members. All stockholders maintain the same profile in ownership.
A writer for many years, Jann has contributed to television programming revolving around legal issues, written for magazines and web sites regarding the law, and her manuals on real estate law specifics are used in real estate schools in Florida.