Below are 3 important items to consider when deciding to form your LLC as an S Corp (1120S) or a Partnership (1065):
- Taxes
- Only S-corporations can divide their profits into two categories: salaries paid to shareholders and dividends/distributions. The latter category is passive income on which self-employment taxes cannot be levied. Partnership co-owners, on the other hand, must pay self-employment taxes on their share of profits.
- In a partnership, general partners pay self employment taxes on all their business income from the partnership, whether it’s distributed or not. Limited partners are subject to SE tax only on any guaranteed payments for services they provide to the partnership. The rationale is that limited partners, who have no management authority, are more alike to passive investors.
- Ownership
- Partnerships can be owned by individual people, other for-profit business entities, and financial and estate-planning structures. Partnerships are also free to create and issue different classes of partnership interest, each with its own bundle of voting, management, and capital contribution and income distribution rights and obligations.
- S corporations are strictly limited by federal tax law to a specific capital structure and ownership profile:
- An S corporation must have only one class of stock, but it can issue non-voting shares that are otherwise identical to the voting shares.
- An S corporation can have no more than 100 shareholders, but spouses, certain family members, and their estates sometimes count as single shareholders for purposes of this limit.
- All S corporation shareholders must be individuals, estates, certain kinds of trusts, or entities that are exempt from federal income tax under Sections 401(a) or 501(c)(3) of the U.S. Tax Code.
- No S corporation shareholder can be a nonresident alien.
- Simplicity
- Given the lack of formalities and stockholder rules involved in a partnership, this structure may be better for your business if you want to avoid large amounts of paperwork and maintenance, allow for easy transference of ownership shares, or operate with fewer worries about strict compliance with government regulations.