The Tax Advantages of LLCs Over S-Corporations

By William Pirraglia

Limited liability companies and S corporations are quite similar from a tax perspective. They are, however, quite different from a legal structure comparison. The most prominent tax advantage of an LLC is its ability to "choose" how it is taxed. A corporation has only two options: to be taxed as a regular C corporation or to be taxed as an S corp, pursuant to Sub-chapter S of the Internal Revenue Service code.

Limited liability companies and S corporations are quite similar from a tax perspective. They are, however, quite different from a legal structure comparison. The most prominent tax advantage of an LLC is its ability to "choose" how it is taxed. A corporation has only two options: to be taxed as a regular C corporation or to be taxed as an S corp, pursuant to Sub-chapter S of the Internal Revenue Service code.

Different Legal Entities

LLCs are "creatures of the state," not really recognized by the federal government or IRS. S corporations are legally the same as standard (C) corporations. They simply choose to be taxed under the regulations of Sub-chapter S or the IRS code. LLCs, while legal entities of the state in which they are formed, must select their preference for tax treatment -- no choice of which is to be taxed as an LLC. There is no provision in federal law for the existence or tax treatment as an "LLC."

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LLC Tax Treatment Choices

Multi-member LLCs can choose to be treated as S corporations, C corporations or partnerships. Single-member LLCs (one owner only) can opt for S corp, C corp or sole proptietorship tax treatment.This flexibility can generate tax savings, if used properly. However, in some cases, this potential benefit becomes a detriment when compared to legal S corps. Single-member LLCs have the greatest potential for detriment as the IRS calls them "disregarded entities" if you select sole proprietorship tax treatment. You would then be subject to all self-employment taxes when you prepare your Schedule C for your annual tax return.

S Corp Tax Treatment

An S corporation is not a separate entity from a C corporation. Unlike an LLC, which must select an existing tax treatment, since no LLC tax rules exist, an S corp follows all regulations of a C corp, except for its tax treatment. Selecting S corp treatment makes it look much like an LLC. An S corp is treated as a "pass through" entity, like an LLC, paying no corporate taxes on its profits. However, even single-owner S corps are liable for payroll taxes for all wages paid. All remaining profit, however, is passed through to S corp owners, to be included in their personal tax returns.

Tax Considerations to Receive Tax Benefits

While you must consider other operating issues when choosing between an LLC or S corp, tax liability is always prominent. The most decisive concern with an LLC is your choice among S corp, C corp and sole proprietorship tax treatment. Since corporate tax rates, although often changed, typically are higher than personal tax rates, a sole proprietorship is often the best option for single-member LLCs. However, should you draw an impressive salary from your LLC, and pay your payroll taxes as required, your lower profit after subtracting your compensation, may benefit from S corp treatment more than proprietorship treatment.

Partnership Vs. LLC Tax Considerations

If your LLC is really a partnership, you typically benefit from LLC treatment instead of incurring the extra cost of forming, filing and maintaining an S corporation. For tax purposes, the LLC will funnel all profits to the partners for inclusion in their personal tax return. Partners also enjoy the personal asset protection they are denied in a legal partnership structure.

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The Legal Definition of LLC

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