LLC Vs S-Corporation?
We all know that both the corporate and LLC form provide limited liability to the owner. However, there are specific reasons to choose one entity over the other.
What Are The Advantages Of An LLC?
LLCs Have Less Filing And Compliance Costs
In general, an LLC with only one member is treated as a disregarded entity. Simply put, the LLC reports its income and activities directly on the 1040 tax return of its owner. This feature of an LLC offers a simpler structure and minimizes the need to file a separate tax return. inherently, this can save clients a lot of money in the form of tax filing fees and potential interest and penalty charges if they forget to file or file their corporate returns late. In addition, LLC’s are not required to have minutes as corporations are in making decisions or elections. In general, a corporation is a more formal business structure than an LLC with specific ongoing requirements during its lifetime.
LLCs Have No Salary Requirement for Owners
In general, an LLC is not permitted to provide a salary to its owners. An owner of an LLC therefore may receive either a draw or a guaranteed payment for his services to the LLC. In effect, an owner can save him/herself the hassle, complexity, and fees of dealing with Payroll. This is especially beneficial to owners who intend to operate a solo practice and otherwise wouldn’t need payroll to begin with.
LLCs Are The Ultimate Business Structure For Holding Rental Real Estate
A Corporation, particularly as S Corporation is required to have no more than 25% of its revenue from passive activities (US Code, Title 26, Section 1375). Doing so for a prolonged period of time can ultimately cost the S corporation to lose its status and revert to a C corporation subject to double taxation.
In addition, if rental real estate is held in a corporation, upon transfer of the property to the owner, it may be deemed to be a sale and subject to capital gains tax. This can be a nightmare scenario where taxes are required to be paid on a transfer. See Publication 542 for more information. In general, holding companies and real estate should be held in an LLC.
ADVANTAGE OF AN S-CORPORATION
S-Corporations Are Investor & Capital Friendly
A corporation is the premier entity for entrepreneurs interested in acquiring capital or taking their business public. The corporate entity has been around for a very long time which makes investors more comfortable because of the clarity and precedence the courts have provided over the years. Of course a corporation’s perpetual existence also provides for more stable operations long after the original owners have passed away. Just think about all the huge corporations that we buy products from today; most have been in business for over 100 years!
S-Corporations Provide Potential For Reduced Self Employment Taxes
In general, all non-passive income earned by an LLC is subject to FICA aka “Self-Employment” taxes. There are exceptions, particularly for “limited” or passive partners not involved in day to day operations of the LLC but in general, all non-passive income earned by an LLC subjects their owners to these taxes. However, as an owner of a Corporation, only the salary of an owner/officer is subject to these taxes. With FICA taxes being as high as 15.3%, this can be a significant savings and a strong enough reason for choosing an S Corporation. Keep in mind that the salary must be reasonable. Here is a highly simplified example:
Assume you are the full owner of an LLC that sells toys.
In 2016 you had net income of $100,000 and are ready to file your taxes.
In this highly simplified example, the $100,000 income will be subject to Self Employment taxes at a rate of 15.3%, This calls for a total Self-Employment tax bill to you of about $15,300.
Remember, this is above and beyond any regular Federal income tax that you may owe!
Lets assume you still sell toys but this time you are the sole owner of an S Corp instead of an LLC.
You figure that a comparable worker that fits your job description should earn a $50,000 salary.
Therefore, the total Self Employment or “FICA” taxes would only be about $7,650. This effectively slashes your FICA tax bill in half!
Keep in mind your regular Federal Income tax bill remains the same in both scenarios.
S-Corporations Allow For Free Transfer of Shares
As a Corporation, an owner has the free right to transfer your shares to any new or existing Qualified Shareholder.
As an LLC, if there is a transfer of more than a 50% ownership interest in an LLC, it may cause the entity to be terminated. Refer to US Code, Title 26, Section 708 for more information.
An owner of an S Corp has more flexibility when it comes to selling their business. They may sell the assets of the corporation or they may simply transfer their shares in the corporation. An LLC may not have such an option and therefore it may subject other members to taxes upon its sale or termination.
Both LLCs and S Corporations are widely used entities to run a business. Your unique situation may not have been addressed by this blog and you may still have questions. We can help. Please feel free to fill out the contact us page and one of our team members would be happy to answer all your questions. Alternatively, you can give us a call or visit our office in person, Monday – Friday from 10:00 am – 6:00 pm.