Deciding between an LLC vs S-Corp for your new business?
LLC vs S Corp: Benefits and Disadvantages
An S-Corporation is a seprate tax entity, a Limited Liability Corporation (LLC) is not. An LLC is a "pass through" entity, such as a partnership or sole proprietorship. All of the profits and losses of the LLC are reported on the owners personal tax returns. The LLC itself does not pay federal income taxes, but some states do charge the LLC itself a relatively small tax. For example in California the state charges LLCs an $800 business tax.
The LLC is a popular new type of hybrid business structure that is now allowed in most states, including Florida. It is designed to provide the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership. The owners are members, and the duration of the LLC is usually determined when the organization papers are filed. Formation is more complex and formal than that of a general partnership and requires a certified operating agreement. Although, the process is more complex than forming an S-Corporation, it is still relatively easy, especially with help from In Balance.
Determining the type of legal structure for a new business is important, especially if your business may be at risk for lawsuits. Your assets may be on the line, depending on the decision you make. Corporations and limited liability companies (“LLCs”) are preferred business structures because, unlike sole proprietorships and partnerships, both offer liability protection. This means that the owner of a company cannot be held personally responsible for the company’s debts. The personal assets of an owner are shielded from company liabilities. S corps and LLCs are similar in that they are technically both “pass-through” entities for tax purposes; the profits and losses of these companies are handled directly by their owners and reported on the owners’ personal income tax returns. C corporations are subject to corporate income tax, pass-through entities such as S-Corps and LLCs remove the double taxation incurred by owners of a standard corporation, or C corporation.
What entrepreneurs and business owners are really considering when addressing the "llc vs S corp" question is which tax accounting classification they should choose. Here are some basic issues to consider:
Investments and businesses that generate losses are often best operated as a sole proprietorship or partnership so that the losses pass through the limited liability company and onto the owner's tax returns and create tax deductions.
S corporations are often best if the LLC operates an active trade or business and self-employment taxes on the owner(s) are high.
Often times an LLC or partnership in the early years of the business is best when profits are low or there are losses. Later on, when the business is profitable, you'll want to have your business treated as a C corporation or S corporation. (Its easy to peform the business amendment and transformation from an LLC).
If an LLC holds real estate or other passive investments, an S corporation or C corporation is usually a very poor choice since the corporation may create an extra level of taxation.
If an LLC operates an active trade or business that does business in many states, a C corporation is often easiest for the owners because the business can often reduce the multistate income tax accounting burden.
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Not sure where to begin, or what type of business structure to form? Let In Balance figure it out for you, or help walk you through the decision.
So what is the difference between an S corporation and an LLC? And which structure is right for you?
If operational ease and flexibility are important to you, an LLC is a good choice. If you are looking to save on employment tax and your situation warrants it, an S corporation could work for you.
It is crucial to do a little research before making this decision. There are benefits and disadvantages to each one. Make the best decision quickly with a little help from In Balance. Give us a call (239-774-5100) or send us an e-mail for a free consultation.
LLC vs S Corp: Benefits and Disadvantages
Benefits and Disadvantages of LLC
Benefits of an LLC
Limited Liability: Owners of a LLC have the limited liability protection of a corporation.
Flexible Profit Distribution: Limited liability companies can select varying forms of distribution of profits. Unlike a common partnership where the split is 50-50, LLC have much more flexibility.
No Minutes: Corporations are required to keep formal minutes, have meetings, and record resolutions. The LLC business structure requires no corporate minutes or resolutions and is easier to operate.
Flow Through Taxation: All your business losses, profits, and expenses flow through the company to the individual members. You avoid the double taxation of paying corporate tax and individual tax. Usually, this will be a tax advantage, but circumstances can favor a corporate tax structure.
Disadvantages of an LLC
Limited Life: Corporations can live forever, whereas a LLC is dissolved when a member dies or undergoes bankruptcy.
Going Public: Business owners with plans to take their company public, or issuing employee shares in the future, may be best served by choosing a corporate business structure.
Added Complexity: Running a sole-proprietorship or partnership will have less paperwork and complexity. A LLC may federally be classified as a sole-proprietorship, partnership, or corporation for tax purposes. Classification can be selected or a default may apply.
Benefits and Disadvantages of a Subchapter S Corp
Subchapter S Corp
To qualify for an S Corporation, 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 income tax returns of the respective shareholders of the S-Corporation.
S-Corporation profits and losses are not taxed corporate income tax like they would be if the corporation remained as a C Corporation.
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 himself 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.
Benefits of the S Corporation:
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.
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