LLC Vs. S Corp Profit Sharing

By Timothy James

A limited liability company, or LLC, and S corporation are both popular business structures that usually protect their owners from liability in their personal capacities. An LLC's owners are referred to as "members," while an S corporation's owners are referred to as "shareholders." Whether you're picking the appropriate entity for a business or trying to divide the profits of an existing business, you'll need to carefully consider the profit sharing rules that govern both forms of ownership.

A limited liability company, or LLC, and S corporation are both popular business structures that usually protect their owners from liability in their personal capacities. An LLC's owners are referred to as "members," while an S corporation's owners are referred to as "shareholders." Whether you're picking the appropriate entity for a business or trying to divide the profits of an existing business, you'll need to carefully consider the profit sharing rules that govern both forms of ownership.

Taxation

The Internal Revenue Service allows both LLCs and S corporations to function as disregarded entities, meaning their corporate structure is disregarded for tax purposes. In other words, the corporate entity doesn't pay taxes. Instead, profits and losses pass through to the owners, who are taxed at the individual level. This means that profits are only taxed once, minimizing the overall amount of taxes paid in many circumstances. LLCs may also elect to be taxed at the corporate level.

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S Corporations and Profit Sharing

The owners of an S corporation can only issue a single type of stock and must distribute profits to shareholders based on the percentage of stock owned by each. For example, if a shareholder owns 30 percent of stock in a company, he must receive 30 percent of the profits for tax purposes. Failure to keep this rule prompts the IRS to set aside the S corporation's favorable tax status.

LLCs and Profit Sharing

When an LLC elects to do business as a disregarded entity -- meaning it does not pay corporate taxes -- its members can divide profits as they see fit. For example, one member may own 75 percent of the business but agree to receive only 50 percent of the profits. Members who invest more time or money into the LLC can legally receive more of its profits, regardless of the percentage owned by the member.

Owner Compensation

When an owner of an LLC works for the LLC itself, he is considered self-employed and his compensation is deemed an equity distribution from the LLC. By contrast, when a shareholder works for an S corporation, he is considered an employee and his compensation is deemed a wage, just like any other employee. Thus, his compensation does not affect the proportion of profits he receives when it comes time for profit distribution.

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Can an S Corporation Be a Member of an LLC?

References

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Advantages & Disadvantages of a Single-Member LLC

An LLC enjoys the limited liability of a corporation, and the potential tax benefits of a disregarded entity. State law regulates LLCs and determines whether single-member LLCs are allowed. Single-member LLCs may enjoy tax benefits, and they offer owners a great deal of control. On the other hand, the informality of an LLC may create difficulties when establishing credit. A single-member LLC has the choice to be taxed as a sole proprietorship or corporation.

LLC Profits and Disbursement Rules

Owners who invest in a limited liability company and become members obtain returns on their investments through appreciation in the value of the business and through the earnings and profits of the LLC. The members may receive periodic distributions of LLC profits throughout the year. However, if members agree, the LLC may retain all earnings and refrain from issuing a distribution.

How Are Profits Split in an LLC?

One of the significant benefits of organizing a company as a limited liability company, called an LLC, is the ability to allocate profits according to the needs of the owners, rather than by the number of shares of stock a person holds. LLC owners, known as members, can choose to split up profits any way that works for them, as long as they elect to be taxed as a partnership.

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