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.
