S Corporations vs. LLCs |
For most small business owners, selecting the right type of legal structure for their business can be an overwhelming task. In most cases, it boils down to a choice between S-corporations and limited liability companies ("LLCs"). Limiting personal liability is the main reason for small business owners to incorporate their business. Both S corporations and LLCs offer liability protection in which the owner of a company will not be held personally responsible for the company’s debts and the personal assets of an owner are protected from company liabilities. Moreover, S Corps and LLCs are both “pass-through” entities for tax purposes; therefore the income of these companies are passed through to their owners and reported on the owners’ personal income tax returns, thereby eliminating the double taxation incurred by shareholders of C corporations. Despite the above similarities, there are also several significant differences between the two entities as described below. Advantages of LLCs (Disadvantages of S Corps) The value of an LLC is the flexibility that allows operational ease to its members. For example, it is possible to vary allocations of profits, losses, and other tax attributes. If a shareholder owns 50% of the outstanding stock of an "S" corporation, that shareholder gets 50% of all of these attributes. If a member has a 30% ownership interest in an LLC, on the other hand, he might get a larger or smaller percentage of distributions, depending on how the Operating Agreement is drafted. This can be a big incentive for bringing in passive investors or can allow the parties to direct more cash flow to the person who needs it. S corporations cannot have more than 75 shareholders, non-resident alien shareholders (foreigners), or most non-individuals, like trusts or estates, as shareholders. LLCs can have all types of owners in any number. S corporations are permitted only one class of stock, and the allocation of profits, losses, and other tax attributes must be according to the ratio of the shareholders' percentages of stock. If a principal is going to guarantee the business's debt, then the LLC may give that member more ability to deduct losses than would an "S" corporation. A loan obtained by the S Corporation does not create basis for shareholders in their stock. On the other hand, the members of LLCs can include the company's loan in their basis. A single-member LLC files the same 1040 tax return and Schedule C as a sole proprietor; partners in an LLC file the same 1065 and Schedule C as do owners of traditional partnerships. However, a one-person S corporation must file a corporate income tax return (Form 1120S). Owners of LLCs pay their self-employment tax once a year on April 15 when income taxes are normally due. Advantages of S Corps (Disadvantages of LLCs) The major benefit of an "S" corporation comes with potential savings on FICA and Medicare taxes paid by an active participant in the company. While all income earned by an active member of an LLC is subject to self-employment tax whether or not it is actually distributed, active shareholders of an "S" corporation need only pay such taxes on the reasonable compensation received for their services as employees; distributions will not be subject to such taxes. However, the IRS pays special attention to S Corps owners who try to lower the salary and attribute the rest of one’s earnings to distributions in disproportionate manner. If the IRS finds a salary to be unreasonable compared to distribution amount, the IRS will reclassify distributions as salary and it may impose penalties. There is no single entity that works for every business. This is why it is important to make accurate financial projections before making the choice. We strongly recommend that you as small business owners seek advice of a business attorney or a CPA who can assist you in choosing the better structure for your unique business. |
| Deming, Parker, Hoffman, Campbell & Daly, L.L.C. |
| Attorneys At Law Since 1974 |
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