LLC vs S Corp- An LLC is not a separate tax entity like a corporation; it is what the IRS calls a pass through entity, like a partnership or sole proprietorship. All of the profits and losses of the LLC pass through the business to the LLC owners , who report this information on their personal tax returns. The LLC itself does not pay federal income taxes, but some states do charge the LLC itself a tax. Use the links on this page and take advantage of the LLCs and S Corporations that will be most beneficial to your business.
The LLC is a relatively new type of hybrid business structure that is now permissible in most states. It is designed to provide the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership. Formation is more complex and formal than that of a general partnership.
The owners are members, and the duration of the LLC is usually determined when the organization papers are filed. The time limit can be continued if desired by a vote of the members at the time of expiration. LLC's must not have more than two of the four characteristics that define corporations: Limited liability to the extent of assets; continuity of life; centralization of management; and free transferability of ownership interests.
LLC vs S Corporation: Advantages and Disadvantages
S Corporation: To qualify, generally, the corporation must have a maximum of 75 shareholders who are individuals. Once a corporation makes the Subchapter S election to be an S-Corporation, profits and losses are passed through the corporation and are reported on the individual tax returns of the respective shareholders of the S-Corporation.
This is the same basic "pass-through" treatment afforded partnerships and LLCs. The key distinction of the S-Corporation is that profits and losses are not taxed at the corporate/business level like they would be if the corporation remained as a C Corporation.
An LLC is not a separate tax entity like a corporation; it is what the IRS calls a pass through entity, like a partnership or sole proprietorship. All of the profits and losses of the LLC pass through the business to the LLC owners , who report this information on their personal tax returns. The LLC itself does not pay federal income taxes, but some states do charge the LLC itself a tax.
Advantages and Disadvantages of LLC
LLC Advantages Disadvantages
LLC AdvantagesA limited liability company (LLC) has many advantages as a form of business entity:
Pass through taxation - under the default tax classification, profits taxed at the member level, not at the LLC level - no double
Limited liability - the members (owners) of the LLC, are protected from liability for acts and debts of the LLC.
An LLC can elect to be taxed as a sole proprietor, partnership, S-corp or corporation, providing the correct option for your business.
Can be set up with just one natural person involved or, in some states, one owner which may be an business itself.
No requirement of an annual general meeting for shareholders (in some states, such as Tennessee and Minnesota, this statement is not correct).
No loss of power to a board of directors (although an operating agreement may provide for centralization of management power in a board).
LLCs are enduring legal business entities, with lives that extend beyond the illness or even death of their owners, thus avoiding problematic business termination or sole proprietor death.
Much less administrative work and recordkeeping.
Membership interests of LLCs can be assigned, and the economic benefits of those interests can be separated and assigned, providing the assignee with the economic benefits of distributions of profits/losses (like a partnership), without transferring the title to the membership interest.
Earnings of most members of an LLC are generally subject to self-employment tax. By contrast, earnings of an S corporation, after paying a salary to the shareholders working in the LLC, can be passed through as distributions of profits and are not subject to self-employment taxes.
Since an LLC is considered a partnership for Federal income tax purposes, if 50% or more of the capital and profit interests are sold or exchanged within a 12-month period, the LLC will terminate for federal tax purposes.
If more than 35% of losses can be allocated to nonmanagers, the LLC may lose its ability to use the cash method of accounting.
An LLC which is treated as a partnership cannot take advantage of incentive stock options, engage in tax-free reorganizations, or issue Section 1244 stock.
There is a lack of uniformity among LLC statutes. Businesses that operate in more than one state may not receive consistent treatment.
In order to be treated as a partnership, an LLC must have at least two members. An S corp can have one shareholder. Although all states allow single member LLCs, the business is not permitted to elect partnership classification for federal tax purposes. The business files Schedule C as a sole proprietor unless it elects to file as a corporation.
Some states do not tax partnerships but do tax LLCs.
Minority discounts for estate planning purposes may be lower in a limited liability company than a corporation. Since LLCs are easier to dissolve, there is greater access to the business assets. Some experts believe that LLC discounts may only be 15% compared to 25% to 40% for a closely-held corporation.
Conversion of an existing business to LLC status could result in tax recognition on appreciated assets
Subchapter S Corp
A tax election only; this election enables the shareholder to treat the earnings and profits as distributions, and have them pass thru directly to their personal tax return. The catch here is that the shareholder, if working for the company, and if there is a profit, must pay herself wages, and it must meet standards of "reasonable compensation". This can vary by geographical region as well as occupation, but the basic rule is to pay yourself what you would have to pay someone to do your job, as long as there is enough profit. If you do not do this, the IRS can reclassify all of the earnings and profit as wages, and you will be liable for all of the payroll taxes on the total amount.
Advantages and Disadvantages of a Subchapter S Corp
Advantages of the SCorporation:
The independent life of the corporation makes possible its continuation, and the relatively undisturbed continued operation of the business regardless of incapacity or death of one or more stockholders.
Fractional ownership shares are easily accommodated in the initial offering of stock.
The purchase, sale, and gifting of stock make it possible to have changes in ownership without disturbing the corporation's ability to conduct business.
The requirement that the corporation's finances and records be separate from the finances and records of stockholders reduces the risk of unrecognized equity liquidations.
With only a few exceptions, under the Subchapter S election for taxation as a partnership the S corporation pays no income taxes and corporation income or loss is passed through direct to the stockholders.
To the extent the corporate shield is maintained and other investments and savings of the stockholders are not at risk, the personal life of stockholders is simplified.
The annual meetings of stockholders and consultations with legal counsel can provide stimulus for improved communication within the stockholder group (often a family group) and can provide more comprehensive guidance for management.
Depending on the corporation's business record and the policies and practices of prospective lenders, access to credit and the ability to secure needed resources may be improved.
Earnings representing "return on investment" (interest, rental payments, etc.) are not subject to self-employment tax as long as stockholder-employees receive adequate compensation for labor and management of the business.
Disadvantages of the S Corporation:
Lenders may require personal guarantees from corporate officers as a condition of supplying credit, thus negating the limitation of liability.
Conflicts or disagreements among the stockholders may immobilize decision making.
Restrictions on the sale of stock and/or buy-back agreements included in the bylaws may prevent minority stockholders from being able to recover the value of their investment in the corporation.
Through the processes of gifting and inheritance, stock ownership can become divided among many persons who are not active in the business and they may become a voting block that does not support needs and decisions believed desirable by managing stockholders.
Over time, corporation paid benefits for stockholder-employees may become costly and exceed the ability of the business to pay.
Employment benefits such as life insurance, health insurance, and housing costs are taxable income to stockholder employees with 2 percent or more stock ownership and to employees who are directly related to persons owning 2 percent or more of the corporation stock.
If appreciated assets are owned by the corporation and the corporation is dissolved, significant income taxes on the appreciation amount will be generated.
Federal Tax Forms for Subchapter S Corporations
Form 1120S: Income Tax Return for S Corporation
1120S K-1: Shareholder's Share of Income, Credit, Deductions
Form 4625 Depreciation
Form 1040: Individual Income Tax Return
Schedule E: Supplemental Income and Loss
Schedule SE: Self-Employment Tax
Form 1040-ES: Estimated Tax for Individuals
sub-chapter S of the Internal Revenue Code by filing IRS Form 2553.