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.

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."

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.

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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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Tax Advantage of LLC Over S Corp



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Can I Convert an LLC to an S-Corp?

Converting an LLC to an S corp is possible, but should be done carefully. The advantages of each business structure are offset by potential disadvantages. From a tax treatment perspective, the advantages and ramifications are roughly equal. However, from an company expansion point of view, the differences can be important. In all cases, conversion will come with some expenses that are unavoidable.

S Corporation Passive Income Restrictions

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Classification of a corporate entity as a C corporation rests entirely on whether it’s subject to the income tax rules in subchapter C of the Internal Revenue Code, or IRC. The C corporation designation solely relates to income tax, so states make no distinction when you create the entity. However, many state taxing authorities recognize the designation for state income tax purposes.

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