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LLC
In an LLC,
there are no restrictions on ownership. An S Corporation, on the other hand, does
have restrictions on ownership. To
hold an S Corporation status, one must be a resident and citizen of this
country. No more than 100 people are
allowed to own stock. If the ownership
requirements are violated, the company losses its S Corporation status and it
can not attain S Corporation status for a number of years.
With an LLC,
these restrictions do not exist and its status is not jeopardized. While most LLCs
will maintain membership of well under 100 members, the option or ability to
expand the number of investors rapidly does exist. Many immigrants just starting business can
benefit from this form of business as well without suffering from double
taxation.
There are
fewer formalities in maintaining an LLC.
This is a major convenience and aides in limiting liability. The types of businesses identified here are
all subject to being disregarded as an entity if the owner does not obey
formalities. This is what is known as
“veil piercing” and it happens when company owners do not observe formalities
in paperwork, meetings, and otherwise use the business as an “alter
ego”.
While the
owner of the business can not use the company as an alter ego to defraud
people out of money, the LLC does not require the formalities that
corporations do. Hence the LLC can be
a better insulator against liability if maintenance of meetings and documents
is going to be an issue.
Shares of an
LLC are easier to put into a trust than an S Corporation. To put shares of an S corporation into a
trust, special trusts must be used. It
can be somewhat complicated and LLCs tend to work
very well instead of S corporations if you want to transfer ownership through
a trust.
No
unemployment taxes are due on income, unlike both the C Corporation and S
Corporation. While this is not a huge
tax savings, it is a significant savings.
If your business is going to make less than 10,000 dollars per year, LLC’s may be the way to go. If you’re an at home business, this is
particularly important.
During
operation of an LLC, profits are taxed only at the shareholder level as
opposed to C Corporations, which are taxed twice. However, profits from the operation of the
business “flow through” to the income statement of the owner. This does not mean distributions are taxed
immediately; the income of the LLC is taxed to the owner within the current
quarterly period. This can be a
significant disadvantage if the LLC does not pay out much in distributions. Owners can find themselves facing large tax
bills with out the cash to cover it if regular distributions are not made.
When winding
up the affairs of the entity and dissolving, profits are taxed once. Nearly all, if not all businesses will
eventually close their doors. Both the
LLC and the S corporation offer the owners the chance to close the doors and
be taxed only once on the sale of the assets. This is in contrast to C
Corporations, which can be hit very hard with taxes upon dissolution of the
corporation.
LLCs are becoming more
popular. This is because most business
owners want a limit on liability, single layer taxation, want to limit the
formalities and still enjoy the protections.
Few attorneys know the advantages of the LLC, but with time, it will
be more known.
S Corporation
Profit is not
subject to self employment taxes. The
self employment tax is 15.3% for those who are self employed and encompasses
both Medicare and social security taxes.
Normally when a person is employed by an employer, their employer pays
half of the tax subjecting the employee to only paying half of the full
tax. When one is self employed, they
must pay the full tax by themselves.
Under the use of a Subchapter S Corporation, salary (not profit) is
subject to self employment tax.
However, if the salary is insufficient, the IRS can reclassify the
profits as a salary subjecting them to self employment taxes.
This is in contrast to LLCs. While operating under an LLC, both salary
and profits are subject to self employment taxes. For people with incomes below the social
security threshold amount, this can result in a significant amount of money
being put into Self Employment taxes.
Of course this can be good or bad depending on your retirement
planning needs and expectations.
Since S
Corporations are flow through entities, losses can be deducted. This also holds true for the LLC. However, this is in contrast to C
Corporations in which shareholders cannot deduct losses. If an S Corporation is experiencing losses,
it can deduct the losses and the owner will recognize the loss on his or her
income statement leading to a lower tax liability. However, there is a
limit. You cannot deduct amounts that
exceed your investment and loans to the company.
During
operation of an S corporation, profits are taxed only at the shareholder
level as opposed to C Corporations, which are taxed twice. Just like with the LLC, the profit, not the
distributions are taxed. This can be
good or bad depending on the situation.
When winding
up the affairs of the entity and dissolving the business, profits are taxed
once. This is in contrast to C
Corporations, which can be hit very hard with taxes upon dissolution of the
corporation. As stated above, all
businesses close their doors and their assets are sold at one point or
another. With an S corporation this
transfer is only taxed at the shareholder level.
Of less
importance, the franchise fee and start up filing fees that S Corporations
pay are substantially less than that of LLCs. Generally S Corporations will pay in the
area of $25 per year in fees and LLCs can pay $300
- $500 per year.
C Corporations
Even though C
Corporations are taxed once at the corporate level and then at the
shareholder level, certain tax advantages can come into play due to new tax
legislation.
Profits from a
C Corporation to a shareholder are what is known as
dividends, and not distributions.
Dividends from C Corporations enjoy a special rate of tax at 15%. This means that money received from a C
Corporation, no mater if it is $1 or $1 million, every dollar is taxed at 15%
and it is not subject to ordinary income tax rates.
At the
corporate level, C corporations enjoy lower tax rates than most people do at
nearly any income level. If your
income is low enough, you may be able to use this to your tax advantage. Generally if the corporations’ income is
below $75,000, it can be to the advantage of the corporate holder to use a C
Corporation.
Fringe
benefits are nontaxable to shareholders of C Corporations. This is in contrast to LLCs
and S Corporations where the owners are taxed on the value of the
benefits. The fringe benefits are
fully deductible at the corporate level, in a C Corporation.
There are no
ownership restrictions when owning a C Corporation. Unlike the S Corporation, there are no
ownership restrictions for a C Corporation.
Nearly any person in the entire world, United States citizen or not, can
own the stock. There is also no
restriction on the number of shareholders.
This works out well for publicly traded companies such as GE, Ford,
and GM. Had there been a restriction
on ownership in these situations, they would have lost their status long ago.
Shareholders
do not pay self employment taxes on C Corporation dividends. When dividends are distributed, they get
taxed at the federal 15% rate and the state tax rates. Medicare and Social Security taxes are not
paid on dividends. However, the IRS is
fast to reclassify dividends as salary subjecting them to self employment
taxes if the salaries are not reasonable.
Shareholders of
C Corporations do not immediately recognize income. If you plan on starting a company and not
distributing profits, C Corporations are good for this. Otherwise, the shareholder would have a lot
of income on their income statement and no dividends or cash to pay the tax
bill with. Having a C Corporation
allows the business person to accumulate a large amount of profits, reinvest
them, etc. and not have to pay taxes at a personal level.
Conclusion
There is no one “be all, do all” separate entity for the business man
or woman. Each entity has subtle
differences which can make a substantial difference to the business
owner. When deciding which entity type
to go with, consider tax and legal aspects to the full extent necessary. The Center is well adept to providing,
setting up and maintaining entities such as those discussed above. Call The Center for these and all of your
other financial, legal, and tax planning needs.
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