LLC Answers » LLC v. Corporation or Sole Proprietorship

S Corporation or LLC: Learn Why the LLC is Chosen Most of the Time

admin — Wed, 14 Apr 2010 16:26:48 +0000

If you are deciding between the S corporation and a limited liability company, you may be interested in the recent trend which shows that most business owners are choosing the LLC.

This is because it has the option of being taxed as an S corporation. As a result, you get the tax treatment you are looking for plus all the benefits of the limited liability company. Benefits include much easier business vehicle to operate and a more flexible entity that can be tailored to meet the needs of most any situation.

S Corporation Summary

An S corporation is really only a tax designation. In order to form one, you incorporate a regular corporation in accordance with state laws. Then you make what is known as an S election with the Internal Revenue Service.

In order to obtain this status, you legal entity must meet certain restrictions such as having a limited number of shareholders and generally the type of shareholders are limited to natural persons (with some limited exceptions).

If your corporation meet the requirements and you make the election in a timely manner, then S corporation status gives your business a single layer of taxation. In other words, you avoid the double taxation of a C corporation.

It is really important that as your business grows and changes, you are always checking to confirm that your business remain compliant with the S corporation tax rules. Failure to meet them, even if by accident, can result in significant tax consequences and penalties.

LLC Summary

This entity is relatively newer than the corporation but it provides the same level of personal liability protection as the corporation.

However, it was designed to be a practical vehicle for small business. The laws allow for businesses to cater the operational and governance structure to the specific business needs. Plus, you can avoid many of the corporate formalities which are not required with an LLC.

The limited liability company automatically qualifies for a single layer of taxation which is similar to S corporation. However, unlike the S corp rules, there are no requirements that must be met at all times and there is no required election. You can avoid double taxation without any risk.

Taxation Analysis

Now, there are some differences in tax treatment between LLC and S corporations and the most popular difference relates to self employment taxes. Depending on the nature of your business, there is a potential method to reduce this tax with S corporation treatment that is not available to a limited liability company.
Given the complexity of this area of tax, you should consult with your accountant to determine if S status may be beneficial to your situation. But here is the secret that until now most people did not know.

If you find that you will benefit more from S corp taxation, you do not need to form a corporation because the Internal Revenue Service allows for an LLC to elect to be taxed as an S corporation. The election process is exactly the same as you would go through if you formed a corporation for your business.

It has taken awhile for accountants to get updated on this ability and to be comfortable with the limited liability company because for years they were used to using the corporation to achieve pass through tax status. Recently, more accountants are understanding the power of the LLC and advising the use of this entity even in situations where an S election is the recommended tax treatment.

LLC or S Corp? What are the differences?

LLC Staff — Mon, 02 Nov 2009 23:27:49 +0000

Both the LLC and the S corporation offer personal limited liability protection to the owners of each entity.

Both the LLC and the S corporation offer a single layer of pass through taxation so profits of a business run through either of such entities are not subject to the double taxation of C corporations.

The difference comes in when it comes to qualification and to operations.

QUALIFICATION FOR SINGLE LAYER OF TAX

An LLC is formed under state LLC law requirements and once a limited liability company is formed, it automatically qualifies for a single layer of taxation under the Internal Revenue Code. There are no conditions, no filings and no requirements to obtain this preferred taxation structure.

With an S corporation, the owners have to first form a regular corporation under state corporation laws. Once formed, the owners of the corporation and the corporation itself must meet a laundry list of conditions and requirements.

I will not list them here but examples include limitations as to who can be an owner, where owners can reside, and limitations on how the equity is structured in the S corporation.

It is important to know that the S corporation must not only meet these conditions and limitations at inception but throughout its existence so there is an additional, potentially onerous requirement to ensure that as the business grows and changes, it never fails to meet these requirements.

Even accidental noncompliance can result in large tax obligations.

After a corporation has determined it meets and will be able to continually meet the S corporation rules, the corporation must file an election form with the IRS to elect S corporation treatment.

OPERATIONS AND GOVERNANCE

An S corporation is a term defined in the tax laws to qualify a regular corporation for the single layer of pass through taxation (known as partnership taxation). From a non-tax perspective, the S corporation must meet all the formalities and requirements of a regular corporation under state law.

This generally means that it must have a Board of Directors and hold annual shareholder and director meetings. There are more governance formalities and requirements expected out of a corporation.

An LLC is not subject to such formalities and an LLC can tailor its operational and management rules and structures to however it sees fit. In summary, there are less formalities and more flexibility when it comes to using an LLC for operating a business.

SELF EMPLOYMENT INCOME

There is an advantage to being an S corporation when it comes to self employment income. If you plan on running a business that will be generating substantial profits – more than what you would be paid in salary as an executive of a company that runs your business, there is an opportunity to avoid paying self employment taxes on the amount that would be in excess of a reasonable salary to you.

While this can be a significant benefit of an S corporation under the self employment tax laws, the tax laws actually allow an LLC to elect to be taxed as an S corporation (assuming it meets the same conditions and requirements).

What does this mean? This means that when your business gets to a level of producing enough income that the self employment benefit becomes relevant, your LLC can elect S corporation status and gain the same tax benefits.

However, because your entity is an LLC, you still get the lesser formalities and more flexibility under state law to continue to run your business according to your particular needs and circumstances.

So when considering whether to form an LLC or S corp, the S corp was the old way of gaining tax benefits. The LLC is the new legal entity that both state legislatures and the IRS deem to be relevant for the typical small business owner.

It does not bog owners down with legal requirements and formalities and it allows flexibility to accommodate the most simple to the most complex of business requirements.

Sole Proprietor to LLC- Am I Still Liable for Existing Business Obligations?

LLC Staff — Thu, 05 Mar 2009 16:18:24 +0000

The best approach to take when starting a business is to form an LLC from inception and to conduct all business activity through the limited liability company.

However, many business owners start their businesses as sole proprietorship. We get questions from sole proprietors who have been operating without legal liability protection for over 20 years who now want to organize an LLC for protection and other benefits.

An LLC does not exist until the state of its formation processes a compliant filing and issues an official certificate of existence for that business entity. Any business conducted prior to its existence is not protected by the LLC lawyer of protection.

What this means is that an LLC does not protect an owner from any existing personal liability he is subject to prior to the existence of the LLC. Those obligations remain personal.

An LLC does not cover prior existing business debt entered into by an owner in his personal capacity (operating as a sole proprietor) and, even after an LLC is formed, if an owner agrees to guarantee or otherwise be personally liable for a business debt, that personal agreement is not changed by he fact that there is an LLC.

It is still recommended that any sole proprietor form an LLC and transition his or her business to it as this will stop the potential liability with respect to future business activity. First form an LLC and then transfer business assets and contracts to the LLC.

Also, after you form your LLC, there may be a way for you to terminate your existing debt and contract arrangements and have them re-entered into by your LLC. This of course depends on the other party’s willingness to do this. You should seek the advice of an attorney to advise you on the details for how to do this.

LLC or S Corporation for Small Business

LLC Staff — Tue, 24 Feb 2009 20:36:46 +0000

The LLC v. S Corporation dilemma is one that many new business owners come across when choosing a business entity.

An S Corporation Is a Tax Status

It is important to first understand that an S corporation is not a legal entity in the same way that as an LLC, a corporation or a limited partnership entity. An S corporation begins as a general corporation under state law. The “S” is really a tax characteristic under the Internal Revenue Code. So when you are looking at your state laws for different entity requirements, you will not find the S corporation in the corporations and legal entity statutes.

What this translates to is that the only reason to be an S corporation is for tax purposes. An S corporation is a corporation under state business organization law and subject to the same formalities and requirements as a corporation. The corporation generally has more legal mandates and a less flexible structure when it comes to business operations.

An S Corproation Has Limitations and Conditions

Also, from a tax perspective, the Internal Revenue Service imposes a laundry list of requirements and limitations for an S corporation to meet in order to qualify for a single layer of taxation. On the other hand, the IRS automatically qualifies a limited liability company for such single layer of taxation without any requirements of an election or additional restrictions and limitations.

These restrictions and limitations must continually be adhered to and any deviation, even if it is accidental, will result in loss of S status. A loss of S status usually means triggered tax obligations and sometimes penalties and fees. One benefit of the LLC is that you, as a busy business owner, do not have to worry about these. It is one less set of legal compliance requirements you need to keep up with as your business evolves.

While many of these restrictions and limitations may not seem to onerous when starting a business many businesses have later found them to negatively affect their ability to grow or take on financing in later stages. It is sometimes difficult later to unwind an S corporation status if it is needed for business reasons.

An S Corporation Is Subject to Same Formalities and Requirements as a General Corporation

A corporation is simply not as flexible as an LLC when it comes to operations and ownership matters. The corporation statutes structure a corporation with a required board of directors and standard stock ownership. The LLC can alter the legal default structure of an LLC by agreeing to different arrangements in an LLC Operating Agreement.

From a non-tax perspective, the LLC clearly provides a lot more simplicity and flexibility which is important to a small business.

An LLC Can Choose S Corporation As Well for Tax Purposes

From a tax perspective, there is a difference between a default LLC tax structure (which is known as a pass through) and an S corporation tax structure. Both offer a single layer of taxation but there are some technical and sometimes complex differences when it comes to specific tax matters like the ability to take losses, the ability to allocate tax items to owners, and self employment taxes.

Now, having said this, one thing that many do not know. . even some accountants do not know. . is that an LLC can choose an S corporation tax structure if it desires. It requires meeting the same laundry list of requirements and making an election. But bottom line here is that a limited liability company can have all the state law advantages of an LLC but be taxed exactly like an S corporation if this is more suitable.

The S corporation does not have this flexibility in choosing tax structure. The LLC is a newer entity in which both state lawmakers and the federal government (Internal Revenue Service) made it a goal to be most suitable for a small business owner.

One of the many reasons that S corporations are still popular is because accountants are used to using S corporations as they have been around longer and so they advise their clients to use them. Many of these professionals have not kept up to date on the tax rules applicable to the limited liability company. Now, in some situations using corporation that has elected S corporation status may be preferred but make sure that the person advising you is experienced in both types of legal entities when conducting this analysis for your situation.

How to Become a LLC from a Corporation

LLC Staff — Thu, 16 Oct 2008 14:00:07 +0000

This is a pretty popular question asked by existing corporation businesses. The LLC is a much simpler entity to maintain and it offers a lot more flexibility when it comes to structuring ownership and management of a business.

Some states directly address this question. In these states the laws actually have a method for converting an existing corporation in that state into an LLC. This is usually done with the preparation and submission of certain filing documents with the state corporation agency. The specific details are outlined in these legal provisions so in order to do this properly, please consult a local attorney.

If there is no LLC conversion in your state, then there are a few other ways to accomplish this. The first one is to form an LLC and then merge the corporation into the new limited liability company. The merger process is addressed in the corporate and LLC statutes. This process can get technical so it is always advised to get the help of a business lawyer.

Another option for how to become a LLC from a corporation is to simply create a limited liability company and transfer all the business assets from the existing corporation to the newly created legal entity LLC.

In any case, when you are switching legal entities for an existing business, there is going to be a transition process.

Limited Liability Company LLC or Corporation?

LLC Staff — Sun, 28 Sep 2008 02:02:28 +0000

Many business owners want to compare an LLC to a corporation when deciding which legal entity is best for their business.

Both forms offer limited liability protection for their owners.

Generally, the LLC is ideal for the small business enterprise where the ownership is held by one or just a few owners. The LLC offers more tax choices and a simpler structure which has lesser requirements when it comes to maintenance and governance. The LLC is also a more flexible entity which allows owners to operate their business the way they want.

The corporation is the older of the two entities and is definitely the right choice for a company that wants to go public (have an initial public offering) or one that needs to take in venture capital investors as those investors will require a corporation.

The answer of LLC or corporation depends on your specific situation and many factors to into this inquiry including legal, business and tax matters. The LLC Expert has recently launched a more in-depth article about the comparison factors between the two entities: LLC or Corporation?

How to Convert a Sole Proprietoship to an LLC Business?

LLC Staff — Sun, 28 Sep 2008 01:33:40 +0000

Many business owners who currently operate an existing business as a sole proprietorship desire to use a limited liability company for that business. This is the best decision a sole proprietor can make as he or she will benefit from the limited liability protection of an LLC as well as the other many LLC benefits.

Because a sole proprietorship is a business which is not housed in a current legal vehicle (such as an LLC, corporation or partnership), there is only one way to accomplish this. The sole proprietor will form an LLC and then need to transfer the individual assets and liabilities of the current business into the new LLC once formed.

Transfer of assets are typically documented with a Bill of Sale and the transfer of contracts are done by assigning the contracts. If the sole proprietor will continue to own 100% of the LLC (or at least 80%), there generally should be no significant income tax consequences but there are exceptions depending on the specific assets being transferred.

Accordingly, you should always obtain the advice of your accountant and CPA to determine any tax consequences (income taxes, sales taxes, filing fees, etc.). A good accountant may have ways to accomplish the business transfer in the most efficient way.

While a transfer from a sole proprietorship to an LLC is not difficult on paper, it is very important to notify your customers, vendors, employees and all third parties about the new business entity being an LLC moving forward.

While many sole proprietors delay this decision because they do not want to go through the transfer, the longer you wait, the more difficult and time intensive the transfer will be. In the meantime, with each day, you are subjecting yourself and your family to significant liability potential that can be minimized by using an LLC as your business vehicle.

If you are unsure about whether it is worth it to switch to using a limited liability entity such as an LLC, I am the author of a popular article which goes into the what you should be thinking about when deciding whether a limited liability company is worth the benefits you get: Form an LLC v. Sole Proprietorship