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.

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.

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.

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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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Tax Differences of LLCs & PCs

References

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What's an LLC?

An LLC, or limited liability company, is a flexible form of business entity that provides its owners with the safeguard of limited liability. An LLC can have any number of owners, known as members, so the entity is suitable for both sole proprietors and larger businesses. Although each state has its own laws for LLCs that are registered within its jurisdiction, the general rules regarding formation, limited liability, taxation and operation of the LLC are broadly similar.

Can I Have a Partner With an LLC?

A Limited Liability Company is a common business entity that may be owned and managed by one or more individuals. LLCs, formed and managed under state law, are relatively simple to set up, and allow for a flexible management structure. Unlike a partnership, LLC owners, known as members, are not personally liable for the debts and obligations of the company.

What Is a Disadvantage of the Corporate Form of Business Entity?

Compared to other business entities, corporations offer many advantages, such as liability protection and ease of transferring ownership shares. Though corporations are very common, a corporation may not be the best structure for every situation, and it does have some disadvantages.

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