S Corp vs. LLC - Or, Eating One's Cake, And Having It, Too!

[ellyssian]

S Corp vs. LLC, LLC vs. S Corp. What do you want your business to be today?

An ever popular blog topic, let me tell you.

To be an LLC and have certain things you can do, and certain things that get done to you, such as, by default, having all business income slapped on your 1040 and hit with an additional 15% self employment tax to cover social security and medicare; technically, it stops at $94somethingk, and you're left with the 2.9% medicare for everything over and above that magic number.

To be an S Corp, you divvy up the profits amongst shareholders, and slap *that* on your WD40. I mean 1040. Plus, you have to file an 1120S. But you don't get hit with the self employment tax *unless* you 1) do work for the company; and 2) don't draw a big enough W2able salary. If you don't pay yourself a reasonable wage, you essentially wind up getting hit with the a self employment tax on the entire bit, just like with an LLC.

Now, in most of the ever helpful advice found out there on teh intarwebs, you learn that an LLC is greatly simplified over an S Corp. After all, the S Corp has all the strict rules a corporation does, and a board that selects directors to run things, and so on and so forth. Then again, you have some who say an S Corp is easier - and cheaper - to set up than an LLC.

Here's the great part...

There's no such business entity as an S Corp. And there's no such tax entity as an LLC.

So many miss this distinction. I missed it, and I was looking for it. I had Form 8832 in my hot little hands (okay, in a folder on the computer...) and it showed me that, as an LLC, I could decide how I wanted my taxes done: as a sole proprietor, as a partnership, or as a corporation. Hey, cool. But the CPA really wants me to be an S Corp for all the savings expected in taxes.

To add to some confusion, a C Corp, aka just-plain-corporation, gets taxed twice: first, the corp itself pays income taxes; then, when it pays out dividends, the shareholders pay income tax on that same money.

So, as I'm verboten on the whole partnership thing, on account of being the One and Only, that leaves me with the option, via 8832, of deciding I want the IRS - and PA Dept of Revenue - to look upon me as Me or Inc.

Here's that gap in knowledge and understanding, as seen in most advice.

Whichever I decided upon, I would still be an LLC. I wouldn't, as far as all the nasty Corp overhead goes, be Incorporated. Because, well, I wouldn't be. That's a business entity, set by state statute, and my business entity is the same. It's just that the LLC can be taxed as different things.

So my CPA, he wants me to ignore 8832 and go with the 2553, which would make me an S Corp.

See, that's where my confusion comes in. Would form 2553 force me to go through the steps to change my legal business entity to a corporation in addition to using Subchapter S as far as the IRS can see?

It doesn't help that 90% of the advice out there is caged in terms of, as I mentioned, S Corp vs. LLC. It doesn't help that, outside of a few explanations and a few convoluted instructions, people use "S Corp" to mean "a corporation business entity taxed under Subchapter S" and "a business entity taxed under Subchapter S", and what that second one expands to, in reality, is "a corporation or limited liability company or other business entity taxed as a corporation under Subchapter S."

It's like being given some cake to have and to hold, in sickness and in health, forever and always, that you can look at in your hands and digest in your belly at the exact same time.

So I will be able to be an LLC, continue with members and not shareholders, have all kinds of flexible reporting that is not required (which my lawyer says I pretty much need to do anyway, just in case I should need his services and expect to win the case that I am an LLC and the Limited Liability thing should be happening), and, on top of all that, I'll be able to have taxes done as if I was an S Corporation, which means I don't get double taxed, and I don't get stiffed with excessive self-employment taxes provided I pay myself a decent salary, and, most importantly to me, I can pay myself a salary - put myself on the payroll, get withholding and W2s and all that stuff.

I think I finally figured it out. It's a piece of cake.

~"This was a dead end a minute ago..."

"No, that's the dead end behind you!"

~"It keeps changing! What am I supposed to do?"

"Well, the only way out of here is to try one of these doors. One of them leads to the castle at the center of the Labyrinth. The other one leads to-"

"Boo-boo-ba-boom..."

"-certain death!"

"Whooo..."

~"Well which one is which?"

"Umm..."

"...ahh... We can't tell you."

~"Why not?"

"Err..."

"We don't know. But they do..."

~"Oh, well I'll ask them."

"Um... no... you can't ask us. You can only ask one of us."

"It's in the rules. And I should warn you that one of us always tell the truth and one of us always lies. He always lies."

"I do not. I tell the truth."

"Ooh what a lie."

~"Okay, answer yes or no... Would he tell me that this door leads to the castle?"

"Um... Yes."

~"Then the other door leads to the castle and this door leads to certain death."

"How do you know? He could be telling the truth."

~"But then you wouldn't be. So if you told me that he would say yes, then I know the answer would be no."

"But I could be telling the truth."

~"But then he would be lying... So if you told me the answer was yes, the answer would still be no."

"Wait a minute... Is that right?"

"I don't know. I've never understood it."

~"No, it's right. I could never do it before. I think I'm getting smarter. This is a piece of cake."

...falls down a trap door

Comments

[patrixa.livejournal.com]

I've one question: in what language were you writing? It's almost familiar, almost understandable.

[ellyssian.livejournal.com]

Yeah, that's where my head's been for the last four hours...

[nightwind292.livejournal.com]

so, you CAN be both?

[ellyssian.livejournal.com]

You can only BE one - sole proprietor, partnership, LLC, LLP, or corporation. However, if that one is an LLC, you can choose to be taxed in different ways - as a disregarded entity (i.e. the company doesn't exist for taxes, it's all on your individual return), as a partnership, as a C corporation, or as an S corporation. It's just a tax election, though, and not a change to the structure of the company.

[patrixa.livejournal.com]

Are PA and Federal tax rules in sync on this subject? Bill who works with Jim
said while they are LLC, they are partners and so rules are very different -- only advantage is: no PA state tax. He agreed that all these itsy bitsy differences between forms of LLCs are set to try LLCers minds if not their souls!

[ellyssian.livejournal.com]

Most states will go along with what the Feds have for the taxes; there's a few exceptions. Some impose additional taxes; some treat all S Corps as C Corps, so you lose any benefit of the S Corp election.

To my knowledge, no state has LLC as a tax entity; it's strictly a business entity.

If they're an LLC, they can choose to be taxed as a partnership or a corporation - their CPA would have to advise them which is best. Since partnerships aren't applicable to me, I didn't see what it's all about. Might be better taxwise.

There's also the LLP structure, which is a partnership through and through, but with the limited liability. I expect it is limited in other ways, as well, but I've never looked into it more than to know it exists.

That's the thing - the differences that are possible under an LLC are the strength of an LLC. You can get the liability benefits by structuring your business entity as a corporation, but then you get slapped with a lot of restrictions and formalities in how you do business. The LLC structure lets you do things your way, to a degree.

But it does get confusing.

Even getting taxed as an S Corp increases restrictions: you must have no more than 100 shareholders (used to be 35, then 75, so the definition of Small is growing!); you can't have any foreign ownership or ownership by another business entity.

[patrixa.livejournal.com]

What about witches and things that go bump in the night?

I'll see you sooner than you think and then you can 'splain to me --- maybe or maybe I'd rather you cook something!

[ellyssian.livejournal.com]

Well, witches and things that go bump in the night are, like LLCs and S Corps, two different concepts. The tax code concerning witches gets tricky, because there are several different types of entities available. Some are considered valid religions, which entitles them to a non-profit status, and they can run their coven tax-free. Others are considered more of a cartoon or halloween caricature, and those are taxed in a similar manner to LLCs, although they only have the options of filing as a disregarded entity (self-employed) or a partnership.

Those who qualify for nonprofit status have to file Form 990-T (based on the 501(c)(3) exemption criteria, of course). Those who are not operating as a nonprofit must file the 1040 or 1120 & 1065 (along with Schedule M-3), depending on whether they're filing as a disregarded entity or a partnership. They also have to file Form 2947 and Schedule O-31, so there's actually a significant outlay of additional paperwork required.

Now, Things That Go Bump in the Night have to deal with a much more complicated tax code. Technically, if a witch also goes bump in the night, they have the option of choosing which category they want to be taxed as. Things That Go Bump In the Night can file as a disregarded entity, partnership, or corporation - much like the LLC - but they also have the option, provided they meet the criteria specified in statute 6(6)(6), of filing as an incorporeal entity, which, most CPAs will advise, allows them a significant tax savings. However, if they're going to get money back from excessive withholding or overpayments of the estimated tax, they should opt for one of the other tax forms, as its against the federal law to issue a check to an incorporeal entity. Unfortunately, they can only change their entity declaration once every 3.5 millennia, so they are advised to be very accurate when declaring their deductions and/or paying their estimated tax.

[slamlander.livejournal.com]

Consider becoming a Delaware Corp.
That's what I did for my firm and you can do it as one single owner. Most companies are either Delaware or Nevada corps, for tax reasons.

The major differences are liabilities. As a corp, you have the protection of the corporate veil. That is, when your corp gets sued (not if), they are limited to the assets of the corporation and your personal property is exempt. You do have to keep separate books and be careful about co-mingling of funds, between the corp and your personal. This will also reduce your personal liability insurance but you will need a separate liability coverage for the corp. A bit of a bother but, it will safeguard your house.

Also, you are now doing your initial filing, that's important. How you do it now will affect the way the IRS views you forever, even if you change your registration later. As a corp, you will get a separate EIN, just for the corp.

The liability thing was always what made up my mind. As you are finding out, the registration and the tax view are fairly well decoupled.

Yes, there is a double taxation risk, sort of. The key point to remember is that the corp only pays taxes on the NET profits and NOT the gross income. Corps making less than 5MUSD can hide tons in legitimate expenses.

Pay the self-employment tax. It's definitely worth it. You can then still collect a SS pension later.

Become an employee of your own corp and report your salary. If something goes bust later, you can still collect unemployment.

Do a lot of reading between the lines here as there is a bunch that I will never say electronically. Also, with details about my old company, someone could easily draw the lines between the slamlander and my real identity ;)

[ellyssian.livejournal.com]

Pretty much everything you mentioned applies to the LLC (provided you choose to be taxed as a C or S corp) and the only thing that isn't in place is basing the LLC in Delaware and getting the S corp tax paperwork filed. The latter should be done on Monday, and the former... well, as I won't be doing any work outside of PA doesn't seem worth the trouble. Actually registering the business as a corp won't happen for a while, if ever.

I'm definitely going the whole W2/workers comp/etc. salary route - that's actually the big driving force for me. It's playing hell with my estimates - as I'm doing the work, I'm included in the regular labor charges. It's more of a pain to break that out and figure out what I should be getting paid than it is to just treat me as any other employee.

[slamlander.livejournal.com]

Delaware is used because it is next to null taxes and almost nil reporting requirements. But then, I was in California (Silicon Valley) at the time. CA corp taxes are at 34% annually. You only pay state taxes in your state of registration (check with your CPA on that).

[slamlander.livejournal.com]

PS: My company (software consultancy) existed for seven years, showing negative profits for each year, while in California. The only state that is more business hostile is Massachusetts.

[slamlander.livejournal.com]

Run this phrase past your CPA "tax loss carry forward"