Author Topic: LLC taxed as S-corp vs S-corp  (Read 1101 times)

Altons Bobs

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LLC taxed as S-corp vs S-corp
« on: March 06, 2017, 03:20:32 PM »
What is the difference when you incorporate your business as an LLC taxed as S-corp, vs. setting an S-corp (not LLC)?

SeattleCPA

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Re: LLC taxed as S-corp vs S-corp
« Reply #1 on: March 07, 2017, 08:00:37 AM »
Legally, there's a difference between an LLC and a traditional corporation. (That's a state law thing.) LLCs are, for example, easier to govern and require less red tape.

But an S corporation is an S corporation because S corporations are a tax accounting thing. I.e., once you make the election, the tax accounting for an "LLC" S corporation works the same way as for a "Corporation" S corporation.

BTW, I think almost everybody--and probably everybody at this forum--should use an LLC. Also, be careful you don't elect Subchapter S status too quickly. You often optimize by running your operation as a sole proprietorship for first year or years. An S corporation makes sense once your business generates profits well in excess of what a fair salary to you would be for running the business.

P.S. An LLC that's not treated as an S corporation can also be a great way to operate the last years you run a business... when you're in wind-down mode.

FIREby35

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Re: LLC taxed as S-corp vs S-corp
« Reply #2 on: March 07, 2017, 02:49:14 PM »
I'm an attorney. My advice in 99% of cases is exactly what was previously posted.

Axecleaver

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Re: LLC taxed as S-corp vs S-corp
« Reply #3 on: March 08, 2017, 05:31:17 AM »
Seattle, I remember reading a thread in AAM that described challenges (tax, legal) transferring LLC's, if you decide to sell. Do you know anything about that?  Closest I could come to evidence for this was in a fairly technical legal blog: http://www.americanbar.org/publications/blt/2013/12/02_immerman.html

The filing fees are a bit different (CA for example, has a pretty high LLC franchise fee). If you have partners, the LLC is a bit more complex than single member, and has more filing requirements. If you want to add partners later, or sell stock in your company, LLC is harder to do that with.

Papa bear

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Re: LLC taxed as S-corp vs S-corp
« Reply #4 on: March 08, 2017, 06:35:39 AM »
S corps have some limitations: (from IRS.gov)
Be a domestic corporation
Have only allowable shareholders
May be individuals, certain trusts, and estates and
May not be partnerships, corporations or non-resident alien shareholders
Have no more than 100 shareholders
Have only one class of stock
Not be an ineligible corporation (i.e. certain financial institutions, insurance companies, and domestic international sales corporations).

Are the rules the same with an LLC electing to be taxed as an S Corp?


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asauer

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Re: LLC taxed as S-corp vs S-corp
« Reply #5 on: March 08, 2017, 06:54:44 AM »
This is very helpful for me- thanks for posting!

shawndoggy

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Re: LLC taxed as S-corp vs S-corp
« Reply #6 on: March 08, 2017, 06:55:25 AM »
S corps have some limitations: (from IRS.gov)
Be a domestic corporation
Have only allowable shareholders
May be individuals, certain trusts, and estates and
May not be partnerships, corporations or non-resident alien shareholders
Have no more than 100 shareholders
Have only one class of stock
Not be an ineligible corporation (i.e. certain financial institutions, insurance companies, and domestic international sales corporations).

Are the rules the same with an LLC electing to be taxed as an S Corp?


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Yes. Same requirements. Sure for IRS purposes you can just check the box, but it is good to remember that s corps have governance requirements that are inconsistent with most "off the shelf" LLC operating agreements.

My advice is that if you want an s Corp, form a corporation. Any perceived cost savings for going the LLC taxed as s route will likely be chewed up in the course of drafting an S-compliant operating agreement, especially if you have multiple members.

SeattleCPA

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Re: LLC taxed as S-corp vs S-corp
« Reply #7 on: March 08, 2017, 07:38:29 AM »
Seattle, I remember reading a thread in AAM that described challenges (tax, legal) transferring LLC's, if you decide to sell. Do you know anything about that?  Closest I could come to evidence for this was in a fairly technical legal blog: http://www.americanbar.org/publications/blt/2013/12/02_immerman.html

The filing fees are a bit different (CA for example, has a pretty high LLC franchise fee). If you have partners, the LLC is a bit more complex than single member, and has more filing requirements. If you want to add partners later, or sell stock in your company, LLC is harder to do that with.

This isn't my experience--and I have lots of relevant real world experience in this area.

With regard to selling a business, when you sell a small business operated as a corporation, you usually don't sell the stock in the corporation. You sell its assets. That gives the buyer a step-up in basis and lets him, for example, depreciate or amortize the assets he purchases. (Without getting into the details, that same thing will happen either explicitly or implicitly if you sell a small business operated as an LLC and taxed as a partnership or sole proprietorship.)

With regard to state taxes and California, yes, the state taxes suck. But those same franchise taxes apply to S corporations, too. See here for more info:

http://evergreensmallbusiness.com/california-s-corporations-save-taxes/

With regard to complexity of selling an interest in an LLC versus selling an interest in a corporation, I'll one of the attorneys comment on that. But I don't think so...



SeattleCPA

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Re: LLC taxed as S-corp vs S-corp
« Reply #8 on: March 08, 2017, 07:47:19 AM »
S corps have some limitations: (from IRS.gov)
Be a domestic corporation
Have only allowable shareholders
May be individuals, certain trusts, and estates and
May not be partnerships, corporations or non-resident alien shareholders
Have no more than 100 shareholders
Have only one class of stock
Not be an ineligible corporation (i.e. certain financial institutions, insurance companies, and domestic international sales corporations).

Are the rules the same with an LLC electing to be taxed as an S Corp?


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Yes. Same requirements. Sure for IRS purposes you can just check the box, but it is good to remember that s corps have governance requirements that are inconsistent with most "off the shelf" LLC operating agreements.

My advice is that if you want an s Corp, form a corporation. Any perceived cost savings for going the LLC taxed as s route will likely be chewed up in the course of drafting an S-compliant operating agreement, especially if you have multiple members.

I disagree with some of the stuff in both of the above statements.

For one thing, the legal requirements of operating a true corporation are significantly more that the legal requirements of operating an LLC. LLCs are, in essence, "lite" corporations. Like "lite" beer. Or "lite" salad dressing. Think about some of the things that you are typically supposed to do one with a corporation: annual shareholder meetings, electing a board of directors, regular board meetings, electing corporate officers, etc.

Note: Agree that an off-the-shelf LLC operating agreement often would not address typical S corporation issues. But that deficiency appears in off the shelf corporate by-laws, too. I.e., they can skip or omit stuff that's important and revelent to an S corporation and its shareholders.

Finally, another big advantage of operating as an LLC is that you can operate as a disregarded entity during the startup phase and during the wind up phase. I.e., that first year or two with an LLC? And that last year or two? You can operate as a sole proprietorship. That'll mean you can probably prepare your tax returns yourself, avoid payroll taxes, etc.

The corporation option doesn't let you do that.


shawndoggy

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Re: LLC taxed as S-corp vs S-corp
« Reply #9 on: March 08, 2017, 10:56:37 AM »
I disagree with some of the stuff in both of the above statements.

For one thing, the legal requirements of operating a true corporation are significantly more that the legal requirements of operating an LLC. LLCs are, in essence, "lite" corporations. Like "lite" beer. Or "lite" salad dressing. Think about some of the things that you are typically supposed to do one with a corporation: annual shareholder meetings, electing a board of directors, regular board meetings, electing corporate officers, etc.

Note: Agree that an off-the-shelf LLC operating agreement often would not address typical S corporation issues. But that deficiency appears in off the shelf corporate by-laws, too. I.e., they can skip or omit stuff that's important and revelent to an S corporation and its shareholders.

Finally, another big advantage of operating as an LLC is that you can operate as a disregarded entity during the startup phase and during the wind up phase. I.e., that first year or two with an LLC? And that last year or two? You can operate as a sole proprietorship. That'll mean you can probably prepare your tax returns yourself, avoid payroll taxes, etc.

The corporation option doesn't let you do that.

These are great points about the potential flexibility under the tax code.  I'm not arguing that it cannot be done or that it might not be a great idea for a sophisticated enterprise (or at least folks with trusted advisors who are experts in the field)

My concern is more that there are generally default rules baked into most LLC statutes which would, for instance, violate the S-corp single class of stock requirement (different priorities on dissolution).  In order to have a "good" s election for an LLC, you're going to need to understand the s-corp requirements and your local jurisdiction's LLC statute, and opt out of conflicting provisions. 

That's an approach that's going to require the advice of an expert (or two) and is really fraught with peril for the DIY crowd that this forum caters to. 

I'm not the only one who thinks that significant expertise needs to go into drafting an operating agreement to be s-corp compliant, and even then there is some risk.

http://apps.americanbar.org/buslaw/committees/CL983500pub/newsletter/200906/rutledge.pdf
http://www.llcformations.com/pdf/Issue%2041%20-%20Fed%20tax%20provisions%20in%20oas%20of%20LLCs%20taxable%20as%20S.pdf
http://www.kutakrock.com/files/Publication/15c9512b-aa41-4bbc-a3f5-f2abe9acf581/Presentation/PublicationAttachment/77c7d3b5-9c92-434f-b6d6-f325c357ed8a/LLCs%20Taxed%20as%20S%20Corp.pdf

Altons Bobs

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Re: LLC taxed as S-corp vs S-corp
« Reply #10 on: March 08, 2017, 11:16:21 AM »
So when is it a good choice to form an LLC with S-corp tax filing, and when is it a good choice to do an S-corp? 

FrugalGrad

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Re: LLC taxed as S-corp vs S-corp
« Reply #11 on: March 08, 2017, 01:24:53 PM »
I think there are some language differences here. An S-Corp is a tax election. You are either an LLC taxed as an S-Corp, or a Corporation taxed as an S-Corporation (and technically an LLC elects to be taxed as a C Corp and then as an S Corp, but they can be effective at the same time). Either way, you start as one entity and elect to be treated as an S-Corporation (even though the effective date can be the date of incorporation).
Always happy to help with tax or accounting questions - feel free to private message me.

I am a licensed CPA in Pennsylvania. However, any tax advice I give should be considered general information and not used in the avoidance of tax. There is most likely information about your situation that I do not know, and thus you should do your own additional research.

shawndoggy

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Re: LLC taxed as S-corp vs S-corp
« Reply #12 on: March 08, 2017, 01:48:37 PM »
I think there are some language differences here. An S-Corp is a tax election. You are either an LLC taxed as an S-Corp, or a Corporation taxed as an S-Corporation (and technically an LLC elects to be taxed as a C Corp and then as an S Corp, but they can be effective at the same time). Either way, you start as one entity and elect to be treated as an S-Corporation (even though the effective date can be the date of incorporation).

This is true.  And it's also true that the s-election imposes some additional corporate restrictions/formalities on top of the state law formalities that would go along with either an LLC or corporation.  Some of the s-corp formalities are inconsistent with default LLC rules.  if you don't know your way around your state's LLC statute to specifically address those inconsistencies in your LLC's operating agreement, you could inadvertently create an entity that is noncompliant with subchapter s. 

So when is it a good choice to form an LLC with S-corp tax filing, and when is it a good choice to do an S-corp? 

If you have good tax advice and good legal advice, Go for it! 

If you don't have good tax and legal advice, get some.

If you decide to just wing it based on internet sleuthing, without getting professional advice, I'd pick one or the other. 

If you ever bring in a partner / second shareholder, definitely seek professional advice.

SeattleCPA

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Re: LLC taxed as S-corp vs S-corp
« Reply #13 on: March 08, 2017, 01:54:53 PM »
I'm going to quickly respond to Shawn Doggy, Altons Bobs, and Frugal Grad...

Shawn  Doggy:
Good points. And I understand and agree with the issues raised in the first paper. But my professional experience (as a CPA serving a couple of hundred Subchapter S corporations, many which are LLCs or other eligible entities and many which are traditional corporations) is the LLC is easiest and best for the reasons I mentioned. LLCs are easier to operate (and thus harder to screw up)... and that's one big benefit for DIYers. Also the startup phase and the wind-up phase, not mentioned by the attorneys who wrote the first paper, really represents a big benefit that is often missed by little guys. Then there's the charging order issue--which I think they downplay... But all that said, I do agree that the one class of stock issue is easy to screw up--and in a bunch of different ways, including things like using a bad set of governing documents (which you've rightly pointed out) and then even commoner problems like making unequal distributions. One final note: For one member LLCs, most of these concerns are not relevant...

Altons Bobs: I think you elect S status for a regular corporation immediately because operating first as a C corp and then later as an S corp creates tax accounting issues like the built-in gain tax. I think you elect S status for an LLC or other eligible entity at the start (or maybe the end) of the first year for which you earn WAY more than the amount you'll need to fairly call out as reasonable compensation. Figure an 1120S corporation return costs at least $1K... maybe $2K. (These returns are not IMHO DIY.) So you need to be able to recategorize at least $20K as nonwages in order to pay the tax prep fees.)

FrugalGrad:
Good point. And of course, LLCs are the only eligible entities... probably only the most common.
« Last Edit: March 09, 2017, 07:44:27 AM by SeattleCPA »

shawndoggy

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Re: LLC taxed as S-corp vs S-corp
« Reply #14 on: March 08, 2017, 02:17:32 PM »
Then there's the charging order issue--which I think they downplay...

Again, though, this really shows that one size fits all advice can be problematic.  In my jurisdiction charging order protection extends to corps too.  In other jurisdictions, charging order protection only extends to multi-member LLCs and not to single member companies. That's why I'm saying that it's important to get the advice of professionals.

Look, the reason people go through the process of organizing a corp or an LLC is both for tax advantage and liability protection.  Going forward DIY, in my experience, many many many (i.e. the vast majority) will screw up one or both the tax or legal side. 

So sure, LLC taxed as S can work, but it's (again IMHO) not advisable without a pro to guide you.  And back to my original comment, my concern is mostly that any perceived savings will be chewed up with the cost of drafting an s-compliant operating agreement.

SeattleCPA

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Re: LLC taxed as S-corp vs S-corp
« Reply #15 on: March 08, 2017, 07:29:53 PM »
Then there's the charging order issue--which I think they downplay...

Again, though, this really shows that one size fits all advice can be problematic.  In my jurisdiction charging order protection extends to corps too.  In other jurisdictions, charging order protection only extends to multi-member LLCs and not to single member companies. That's why I'm saying that it's important to get the advice of professionals.

Look, the reason people go through the process of organizing a corp or an LLC is both for tax advantage and liability protection.  Going forward DIY, in my experience, many many many (i.e. the vast majority) will screw up one or both the tax or legal side. 

So sure, LLC taxed as S can work, but it's (again IMHO) not advisable without a pro to guide you.  And back to my original comment, my concern is mostly that any perceived savings will be chewed up with the cost of drafting an s-compliant operating agreement.

Fair enough.

BTW, we may agree here more than we disagree. I don't think S corps are a DIY project.

But possibly where we disagree is whether the savings can pay for the costs... here's my thought:

http://evergreensmallbusiness.com/million-dollar-s-corporation-mistake/

shawndoggy

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Re: LLC taxed as S-corp vs S-corp
« Reply #16 on: March 08, 2017, 09:31:52 PM »
Dang man I was gonna say we were totoally on the same page till I saw you were selling 50 state LLC taxed as s kits on your blog. Guaranteed there are some of the very issues I've raised in this thread in those kits.

SeattleCPA

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Re: LLC taxed as S-corp vs S-corp
« Reply #17 on: March 09, 2017, 07:17:37 AM »
Dang man I was gonna say we were totoally on the same page till I saw you were selling 50 state LLC taxed as s kits on your blog. Guaranteed there are some of the very issues I've raised in this thread in those kits.

Most of those are sold to attorneys. For what that's worth.

But, yeah, I don't think we're *totally* on the same page.

As I said, I think you raise a good point... and if you start thinking about the single class of stock issue, you can find all sorts of ways to screw up. Default rules embedded in the statutes... poorly drafted operating agreements (which I've seen come out of big law firms BTW)... and then probably most commonly disproportionate distributions.

The other point about all this--which is really relevant to the MMM crowd probably--is that with a one member LLC this issue should be irrelevant.

BTW, the issue I now really worry about is where someone files the formation or incorporation paperwork but then doesn't *really* begin operating fully as an LLC or corporation. Here's my blog post on that...

http://evergreensmallbusiness.com/s-corporation-paperwork-problems/

And, just to be fair, this is another issue where I've seen law firms do the paperwork but not coach or counsel the client about how to avoid the trouble this guy faced.
« Last Edit: March 09, 2017, 07:24:04 AM by SeattleCPA »

shawndoggy

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Re: LLC taxed as S-corp vs S-corp
« Reply #18 on: March 09, 2017, 07:19:29 AM »
scary.

SeattleCPA

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Re: LLC taxed as S-corp vs S-corp
« Reply #19 on: March 09, 2017, 07:29:43 AM »
As a practical matter--and as I mentioned we do a lot of S corp work--the three big headaches we encounter are:

1. No accounting system--which means taxpayer is going to get beat up in an audit.
2. Unreasonably low shareholder compensation--often enabled by an inadequate payroll system.
3. The "incomplete" nature of the LLC formation or incorporation as discussed in that blog post.

P.S. I just read this pdf you linked to, http://www.llcformations.com/pdf/Issue%2041%20-%20Fed%20tax%20provisions%20in%20oas%20of%20LLCs%20taxable%20as%20S.pdf , and I agree with everything he says.
« Last Edit: March 09, 2017, 07:36:00 AM by SeattleCPA »

SeattleCPA

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Re: LLC taxed as S-corp vs S-corp
« Reply #20 on: March 09, 2017, 07:46:55 AM »
scary.

Hey Shawn, I want to apologize about getting your alias wrong earlier. I've corrected all my errors. But truly I feel bad I bungled that.

I was working with out my reading glasses... (57-year-old eyes...)


shawndoggy

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Re: LLC taxed as S-corp vs S-corp
« Reply #21 on: March 09, 2017, 07:53:04 AM »
Haha ain't no thang. My eyes are right behind yours!


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