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LLC’s vs. S-Corporations: Which Entity is Right for Me?

by Tim Schlotterer

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

+   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.

S-Corporations

+   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?

This entry was posted in Audit & Tax Talk and tagged Accounting. Bookmark the permalink.

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