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May 6, 2014

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Choice of entity update: LLCs and S corporations

Tax considerations have long played a role in businesses’ choices of entity.

This was true even a generation ago, when the main forms of organization were relatively few: sole proprietorships, partnerships and corporations.

It is even more so today, especially with the popularity of relatively new forms of organization: limited liability company (LLC) and S corporations.

In this post, we will take note of how LLCs and S corporations are both now widely popular as entity choices.

An S corporation is a corporation that takes its name from Subchapter S of the federal tax code. It allows net come income to be passed directly to shareholders rather than being taxed at the corporate level.

In other words, the profits of an S corporation are subject only to pass-through taxes. Shareholders pay taxes on these profits, but not the corporation itself.

In this respect, S corporations differ from regular corporations, which are known as C corporations. This is because with C corporations, profits are taxed at both the corporate level and again at the ownership (shareholder) level.

One reason for the popularity of S corporations, then, is to avoid this double taxation.

There are, however, limits on the number of shareholders that an S corporation may have.

To maintain an S corporation, it is also necessary to observe the corporate forms, such as annual meetings, in order to maintain the corporate status. Maintaining this status is important in the event of a lawsuit that may seek to hold owners personally liable for actions of the corporation.

Limited liability companies are similar to S corporations in many ways. In particular, they have the advantage of protecting the owners’ personal assets from liability. LLCs also offer the benefits of pass-through taxation, just as S corporations do.

An important difference between S corporations and LLCs, however, is that LLCs involve the payment of self-employment tax on profits. Owners of LLCs must pay that tax. But self-employment tax is not something owners of S corporations have to pay.

Source: Business New Daily, “S Corporation vs. LLC: Which is Best for You?” Chad Brooks, April 17, 2014

Tax Controversy