There are many important factors to weigh when considering incorporating a business. One of the most vital components to consider is which entity type provides the best tax incentives for a particular business. While LLC’s have gained popularity in recent years because of their flexibility, S Corporations remain a popular entity choice as well. The following highlights a variety of pros and cons of each entity choice:
+ LLC’s have only one level of tax imposed.
+ Contributions of property to the LLC are usually tax-free. This is also true when admitting new partners in the future.
+ A step-up in basis of partnership assets is allowed upon the change of a partnership interest. This allows a new partner additional deductions when appreciated property exists inside the LLC.
+ An LLC has greater flexibility when distributing profits to members as compared to an S-Corporation.
- Tax law is currently unclear regarding the applicability of self-employment tax for LLC members.
- Fringe benefits paid by the LLC on behalf of a partner are treated as guaranteed payments and are not an excludable benefit.
+ Like LLC’s, only one level of tax is imposed on an S Corporation.
+ Distributions from an S Corporation are currently exempt from payroll taxes (assuming adequate compensation is paid to employee-shareholders).
+ Losses incurred by the S corporation may be used on the shareholder’s individual tax returns (provided sufficient basis exists).
- Not all companies qualify to be an S Corporation. An example of a corporation that would not qualify is one who has over 100 shareholders.
- Shareholders must directly invest or make direct loans in order to support the deduction of a flow-thru loss; a shareholder guarantee of entity debt is insufficient.
- S-Corporations must maintain up-to-date corporate minutes.
- Profit, losses and distributions may only be allocated based on one’s ownership percentage in the S-Corporation.
While choosing an entity type often depends on each company’s set of circumstances, LLC’s have become more and more popular based on a variety of options they provide a taxpayer. Which entity choice is right for you?