LLC versus S Corp: How to NOT Make the Wrong Choice
Posted: Friday, December 04, 2009
by Stephen Nelson
Stephen L. Nelson, CPA
Many small business entrepreneurs wonder about the llc versus S corporation issue. Which is understandable in way... People (most who know too little to be opening their mouths) are often pretty quick to offer ill-informed bits of tax law and accounting advice.Ironically, though, an entrepreneur can greatly simplify the llc vs S corp analysis by employing five useful factoids:
Here's the first thing you need to understand. You never have to choose between an LLC and an S corporation. This sounds crazy at first. But you need to understand that an S corporation is not really a corporation at all. Rather, an S corporation is an accounting choice that's available to a bunch of different types of business entities, including regular (traditional) corporations and limited liability companies.
Tip #2: Learn that LLCs Can Be Taxed in Variety of Ways
A second thing to know about LLCs and S corporations: Within reason, an LLC may be treated for tax purposes anyway the owners want.
For example, a one-owner limited liability company may be taxed as a sole proprietorship or as a corporation--including as an S corporation. Similarly, a multiple-owner limited liability company can be taxed as a partnership, as a regular C corporation, or as an S corporation.
Note: The default tax accounting classification for a single-owner LLC operating a business is "sole proprietorship," and the default tax accounting classification for a multiple-member LLC is "partnership."
An important take-away in all this is that your LLC can be taxed as an S corporation (assuming it meets the S corporation eligibility requirements) if you want the LLC taxed that way.
Tip #3: Analyze your Business Tax Burden under Alternative Accounting Classifications
Because an LLC, or limited liability company, can be taxed in a variety of ways, you'll want to think carefully and in detail about which tax accounting classification produces the lowest tax bill.
You may choose to prepare example tax returns as if the business is a sole proprietorship or partnership... or a regular C corporation... or a Subchapter S corporation. And then (for the obvious reason) you simply pick the tax accounting classification scheme that results in the lowest federal and state tax burden.
Tip #4: Don't Rush into Corporate Tax Treatment
A related tip: The llc vs S corp confusion probably comes from people's murky knowledge that businesses often do want to be treated as C corporations or S corporations for tax reasons.
While C or S corporation tax status can save a profitable business income and payroll taxes, don't rush too to C corporation or S corporation status. Corporation tax returns and corporate tax laws are often very complicated and expensive to deal with.
Tip: Oftentimes, businesses save overall costs by forming initially as limited liability companies and then accepting for the first years the default sole proprietorship or partnership tax treatment. Later on, when the business is earning profits, the LLC business can change its tax accounting treatment to "corporation" or "S corporation" status.
Tip #5: Consider Buying Professional Advice about Entity Choice Decisions
One final tip concerning the llc vs. S corporation choice (and similar choices such as limited liability company vs. incorporation): The llc taxation decision is one where purchasing two or three hours of tax law advice can save you tens of thousands of dollars a year in taxes. You'll often, therefore, be able to justify buying professional advice to help you answer this sort of question.
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Bellevue, WA CPA Stephen L. Nelson specializes in helping his small business and entrepreneur clients address thorny issues such as the llc vs S corporation question.
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