Should I form a S corp. or LLC? (And you thought were no such thing as a stupid question.)

All too often I get told, “My financial planner told me to start a S corp.” or “My CPA said I should be a S Corp. instead of a LLC.”

Sadly, these professionals are engaging in the unauthorized practice of law. More disturbingly, they have absolutely no idea what they are talking about.

There is no such entity called a S corp. Let me repeat that. There is no such entity called a S corp.

What is a legal Entity?

A person, or group of people, can create a legal entity. The most common legal entities are corporations, partnerships, and limited liability companies (LLC). A legal entity has legal capacity to enter into agreements or contracts, assume obligations, incur and pay debts, and can be sued for its actions.

Many online articles incorrectly interchange the words corporations and companies. I have even seen articles describing Limited Liability Corporations. (Again, no such thing.) Companies and corporations are two distinct legal entities, and each have a separate legal meaning.

The type of legal entity someone should form is a legal decision based on many factors such as the type of business, who is involved, what risks or liabilities the forming members want to incur, whether asset protection is important, preferred management and payment structure, tax consequences, and numerous other factors. A financial or tax advisor CANNOT give legal advice as to what legal entity is right for you. And if they do, they can be found criminally or civilly liable for their actions.

What is a S corp.?

A S corp. is merely an IRS tax status designation found in the Tax Code, Chapter 1, Subchapter S. For example, a LLC may choose to be taxed one of four ways: 1) S corp., 2) C corp. (found in Subchapter C of the same Tax Code), 3) partnership, or 4) sole proprietorship. Again, there is no such entity called a S corp. It doesn’t exist. It is merely a tax status that a legal entity may elect by filling out IRS Form 2553 in a timely manner. There are requirements as to what types of legal entities can elect this tax status as well as pros and cons for making such a choice.

“Legalese” does matter.

There is a reason to seek out an attorney when making the decision of what legal entity to form, as well as getting advice from a tax professional on which tax designation is best for you. These professionals can help guide you to what is in your legal and tax best interests. Online do-it-yourself document kits cannot walk you through these nuances. If you are serious about starting a business, be a serious business owner and form it correctly. Legalese does matter. Finding that out on the back-end will cost much more than a one hour consultation with an attorney on the front-end.

And if your financial planner or tax person suggests you form a S corp., or that you should be a S corp. instead of a LLC, run away. They do not know what they are talking about.

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