A quick summary of the pros and cons of forming a Limited Liability Company (LLC):
Fewer corporate formalities. Corporations must hold regular meetings of the board of directors and shareholders, keep written corporate minutes and file annual reports with the state. On the other hand, the members and managers of an LLC need not hold regular meetings, which reduces complications and paperwork.
No ownership restrictions. S-corporations cannot have more than 100 stockholders, and each stockholder must be a natural person who is a resident or citizen of the United States. There are no such restrictions placed on an LLC.
Ability to use the cash method of accounting. Unlike a C-corporation, which often must use the accrual method of accounting, most limited liability companies can use the cash method of accounting. This means that income is not earned until it is received.
Ability to place membership interests in a living trust. Members of an LLC are free to place their membership interests in a living trust. It is difficult to place shares of an S-corporation into a living trust.
Ability to deduct losses. Members who are active participants in the business of an LLC are able to deduct its operating losses against the member's regular income to the extent permitted by law. Shareholders of an S-corporation are also able to deduct operating losses, but shareholders of a C-corporation are not.
Tax flexibility. By default, LLCs are treated as a "pass-through" entity for tax purposes, much like a sole proprietorship or partnership. This means that LLCs avoid double taxation. Furthermore, an owner of an LLC is not required to pay unemployment insurance taxes on his or her own salary. However, an LLC can also elect to be treated like a corporation for tax purposes, whether as a C-corporation or an S-corporation.
Profits subject to social security and medicare taxes. In some circumstances, owners of an LLC may end up paying more taxes than owners of a corporation. Salaries and profits of an LLC are subject to self-employment taxes, currently equal to a combined 15.3%. With a corporation, only salaries (and not profits) are subject to such taxes. This disadvantage is most significant for owners who take a salary of less than $97,500 for tax year 2007.
Owners must immediately recognize profits. A C-corporation does not have to immediately distribute its profits to its shareholders as a dividend. This means that shareholders in a C-corporation are not always taxed on the corporation's profits. Because an LLC is not subject to double-taxation, the profits of the LLC are automatically included in a member's income.
Fewer fringe benefits. Employees of an LLC who receive fringe benefits, such as group insurance, medical reimbursement plans, medical insurance and parking, must treat these benefits as taxable income. The same is true for employees who own more than 2% of an S-corporation. However, employees of a C-corporation who receive fringe benefits do not have to report these benefits as taxable income.